QRAFT AI Insights: A Year in Review and Future Predictions for 2024 and Beyond
2023 Review: The Power of AI in Navigating the Volatile Market
In today’s world of constantly shifting markets, investors encounter challenges in adapting, making informed decisions a difficult aspect of investing. Challenges seemed to persist in 2023, as the market faced changes in the macroeconomic landscape, geopolitical tensions, a banking crisis, and the Federal Reserve's interest rate policy, just to name a few. In 2022, numerous experts at prominent investment firms anticipated a negative investment outlook for 2023, predicting a potential recession. However, despite some downturns in 2023 coupled with concerns over inflation, the US economy has displayed resilience. The equity market displayed robust phases at times, accompanied by an increase in corporate profits in specific sectors, particularly technology, gaining momentum spearheaded by the “Magnificent 7” mega-cap tech stocks.
This illustrates the challenge of predicting the market, particularly when our emotions are involved., leading to a more cautious approach to avoid investment losses. While traditional risk-managed strategies aim to navigate market volatility using rule-based approaches, they frequently lag during abrupt market shifts. Additionally, existing indicators and indexes often fall short of providing clear, actionable insights that align precisely with equity and cash allocations.
Qraft Technologies introduced its AI Risk Indicator, a paradigm shift in risk management by leveraging AI’s capabilities and providing alternatives to navigate volatile markets that are systematic, and actionable.
How AI Risk Indicator Works: Transcending Traditional Methods
Qraft’s AI Risk Indicator harnesses the potential of its proprietary AI models to forecast risks in the US equity market. Ultimately, this indicator empowers investors to strategically allocate equity alongside cash in their portfolios, employing its easy-to-interpret scoring methodology. The AI Risk Indicator utilizes a machine learning model that assimilates, analyzes, and processes over 70 macro and market datasets on a weekly basis. It focuses on prevailing momentum, volatility, and correlation metrics, having been trained on data spanning from 1999. As shown in Figure 1, the indicator surged before the market crash in March during the COVID-19 crisis in 2020, predicting a high risk. Then it sharply declined at the beginning after the market hit the bottom, sending a signal for re-entering the market, which was shown highly applicable in navigating the market.
Figure 1. US Equity and AI Risk Level Comparison from 1999 to 2023
Data from November 1999 to December 2023
Market risk is forecasted across three stages: 'Risk On,' 'Cautious,' and 'Risk Off,' each stage linked to a corresponding signal (score) recommending an ideal cash allocation within the US equity portion of a portfolio. A score ranging from 0 to 14 indicates a 'Risk On' market stage, which signifies potentially higher returns from equities in the upcoming week, advising a reduction in cash allocation and an increase in equities. The 'Cautious' stage occurs when the indicator reads between 15 to 49, signaling moderate risk in the equity market. Finally, the 'Risk Off' stage score ranges from 50 to 100, forecasting heightened risk, which recommends reducing equity allocation and increasing cash reserves, suggesting a decline in the equity market in the near future.
Insights from AI Risk Indicator: 2023 Market Recap
The Credit Risk Signal assesses credit market risk and determines the duration allocation between treasury and credit. Depending on the risk signal level, it allows up to 10% allocation of high-yield bonds as a satellite strategy. In bullish market conditions, the model opts to allocate investment-grade bonds, while in bearish times, it favors treasury bonds. The model incorporates both macro data for the bond market and technical data for equity market risk, enabling a comprehensive analysis of market dynamics and risks. Machine learning techniques enhance the model's ability to learn from diverse nonlinear patterns, uncover complex relationships, and adapt to changing market conditions.
Rates and Inflation
Figure 2. Rates and Inflation: Consumer Prices Annual Percent Change, Core Consumer Prices Index, Core PCE Price Index, PCE Price Index, and Federal Funds Rate [2]
Data from January 2020 to October 2023
In 2022, the Federal Reserve began tightening the monetary policy aggressively, after inflation rose to highs not seen in decades (Figure 2). This initiative led to increased volatility in the equity and treasury markets. As yields rose, many regional banks had to sell treasuries they had bought to sure up deposits at a loss as companies made a run on the banks to withdraw their funds. Consequently, Silicon Valley Bank collapsed in March, and the shockwave subsequently impacted other banks such as the Signature Bank and First Republic Bank, both of which closed their operations, culminating in a banking crisis. Throughout this period, the AI Risk Indicator started to send signals in late February and surged to 76 when the equity market declined in March. Later, the indicator dropped as April began, encouraging investors to re-enter the equity market, aligning with the market's rise (Figure 3).
Following this event, the US equity market showed consistent growth. Investors gained confidence following the release of key economic data indicating a decrease in inflation, allowing the market to anticipate that rate hikes may cease. Also, the AI technology boom swept the world following the release of ChatGPT and other AI products and services. Consequently, investors flooded into stocks associated with the AI theme, resulting in positive gains for the technology sector. During this time, the indicator kept a low cash level, aligning with the overall trend in the equity market. Historically, October has been a challenging month for equities. For instance, 50% of the bear markets from 1950 bottomed in October, which was outstanding compared to other months [1]. Similarly, in 2023, the market also experienced a decline in October, a movement the indicator captured by rising to 39 as equities reached their lowest point. However, it plummeted to 0 the following week with the equity market rebounding at the end of October.
As December draws us near the year's end, the AI Risk Indicator has consistently shown 0, potentially signaling the conclusion of interest rate hikes and a potentially bullish for equities. Investors may keep an eye on this indicator considering the potential for the Santa Claus Rally, which typically predicts a 1% to 2% increase in the stock market during the final five trading days of the outgoing year.
Figure 3. 2023 US Equity and AI Risk Level Comparison
Data from January 3rd to December 5th, 2023
2024 Projection: The Power of AI in Navigating the Volatile Market
As we approach the end of 2023, investors are now paying attention to how the market will look in 2024, particularly after a strong year, which was unexpected by most analysts. There were varied opinions from top Wall Street forecasts for the stock market in 2024, with some arguing for an entry into either a bull or a bear market. However, what stands out is the belief in a consistently strong equity market despite macro uncertainties and high rates, contrasting with the pessimistic views held in 2022. This shows humans learn from changes and adjust. Similarly, AI is capable of this, but with a far greater capacity to analyze data much faster and with potentially seeing patterns and relationships in data that humans cannot see. Considering this, the AI Risk Indicator may offer distinct insights presenting more actionable guidance compared to those presented by various media outlets and firms, helping them navigate a volatile market.
Conclusion
In recent history, financial markets have witnessed volatility, driven by heightened inflation and other uncertainties. While no one can accurately predict the future, Artificial Intelligence stands as a valuable tool for investors. If you are looking for investment alternatives and find yourself allocating significant time to researching the 2024 investment outlook, AI, which isn't constrained by rigid rules or human biases, can offer a fresh perspective on navigating drawdowns.
To follow the AI Risk Indicator’s weekly update, click here.
References
1. https://markets.businessinsider.com/news/stocks/stock-market-likely-bottom-october-fundstrat-new-bull-rally-sp500-2023-3
2. https://www.weforum.org/agenda/2023/04/economy-stories-you-need-to-read-this-week/
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