Hi stocksurfer,stocksurfer wrote: ↑Sun Dec 15, 2019 1:59 pmamrap, thanks for the explanation, I do find the "four quadrants" diagrams very confusing. If I understand you correctly, it's not really about 4 quadrants or 4 states, it's really about two separate optimization problems: (1) the selected assets as a mix should react neutrally to rising or falling inflation, i.e., the mix needs to have components that are positively correlated with inflation as well as negatively correlated; and (2) the selected assets as a mix should react neutrally to accelerating growth or slowing growth. Would you agree with that phrasing or am I getting it wrong?amrap wrote: ↑Sat Jan 12, 2019 3:14 am First, it is important to understand that the 4 seasons (states) are relative to the current market expectations (not absolute) and therefore the 4 seasons are:
- Higher than expected inflation (rising prices)
- Lower than expected inflation (or deflation)
- Higher than expected economic growth
For example, the "Higher than expected economic growth" season is not about if the economy will grow but if the economy will grow more than what is expected by the market today, which is reflected on assets prices. This vision is based on the efficient-market hypothesis (EMH, plenty of info on the internet).
- Lower than expected economic growth
Regarding your 9 states concern, these seasons are considered to be independent, so there are only 4 possible states. The fact that 2 states can happen at the same time doesn't mean we have a new state with a different set of assets doing well in it.
By allocating in a balance those assets that do well in specific seasons, the portfolio aims to offer reasonable returns whatever happens in the future while minimizing risks. So, using your example with equities:
- if the economy grows more than expected they will do well (independent effect)
- if inflation grows more than expected they won't be considerably affected (not in the quadrant). Instead, if inflation goes below expectations, equities will suffer (independent effect)
- Whether the resulting effect on equities is positive or negative will depend on the particular circumstances
- If this scenario happens, the return of the portfolio will rely on the rest of assets allocated to these quadrants
There are two factors (growth, inflation) and two possible variations (rising, falling), so there are 4 possible states (the quadrants) and the economy could be in any of them. Ideally, you'd want to have your risk equally exposed to these quadrants.
I'm not sure about your phrasing; I think it misses linking both factors, for example, you'll need assets that do well with raising inflation AND rising growth, etc.). Anyhow, I recommend you to go to the source and study the basics there; Bridgewater has some papers on this, for example, https://www.bridgewater.com/research-li ... -strategy/)