Take Your Pick and Prepare Accordingly - But Stand Ready to Alter Course
In this paper, we mimic the annual process of forecasting the road ahead for markets in the following year from initial forecast to target portfolio. Starting with three variants of a high-level macro forecast on economic conditions going forward, we model each one as a stress test scenario to translate our macro views into predictive market movements for 2019 across multiple asset classes. In a second step, we take a model portfolio and use the stress test results to extract scenario-implied alphas. We then construct optimal portfolio variants for each of our three macro forecasts and analyze the paths from our current portfolio under each macro scenario and to the optimal solution for that stress test. The process described in this paper brings transparency and predictability by aligning portfolio construction and rebalancing with macro views on market conditions.