Whither equity investments?

Found this Paul Singer writing in the Financial Times, dated earlier today. Singer is a billionaire hedge fund manager. Fortune magazine described Singer as one of the “smartest and toughest money managers” in the hedge fund industry:

Investors piling on risk are setting themselves up for a fall

Central banks’ asset-buying spree has created a huge overhang, limiting their ability to support prices in a future downturn

Despite recent jitters over the Omicron variant, global stock market prices remain at or near their highest valuations in history. Bond prices reflect the lowest interest rates in history. And is it any surprise that inflation has broken out of the boundaries of the last 20 years, given the stated goal of policymakers to create more of it? Across the market landscape, risks are building, many of them hidden from view.

Yet, in a surprising twist, a growing number of the largest investors in the world — including socially important institutions such as pension funds, university endowments, charitable foundations and the like — are currently lining up to take on more risk, which could have catastrophic implications for these investors, their clients’ capital and the stability of broader public markets. What is driving this behaviour?

In the main, it is driven by the radically expansionary monetary and fiscal policies undertaken by developed-world governments since the end of the global financial crisis, which were accelerated after the Covid-19 pandemic rattled markets and depressed economic activity last year. And in part it is driven by benchmarking — the practice of institutional investors measuring their performance against a benchmark such as the S&P 500.

As monetary and fiscal policies have pushed securities valuations to new heights, institutional investors have been tempted to overweight their portfolios to stocks, even at record-high prices, for fear of missing out on extraordinary gains. The buying pressure created by these strategies is only driving prices higher and herding capital into risk assets.

At present, risks are at, or close to, the highest levels in market history. For instance, the market capitalisation of all domestic US public and private equities is now at 280 per cent of gross domestic product, much higher than the previous peak of 190 per cent just before the collapse of the dotcom bubble. And household equity allocations are at an all-time high of 50 per cent.

Eventually, rising inflation, rising interest rates or some unforeseen turn of events could cause a substantial stock and bond market decline, perhaps in an unpredictable sequence. What then for the institutional managers when the rush for the exits begins?

One answer might be that the authorities will never allow a sustained downturn in asset prices to happen again. This points to one of the key problems with the current set of monetary and fiscal policies in the developed world: they mask and minimise risks while preventing stock and bond prices from performing their indispensable signalling roles.

Currently, policies across the developed world are designed to encourage people to believe that risks are limited and that asset prices, not just the overall functioning of the economy, will always and forever be protected by the government.

Due to this extraordinary support for asset prices, almost all investment “strategies” of recent years have made money, are making money and are expected to keep making money. The most successful “strategy,” of course, has been to buy almost any risk asset, leaning hard on the latest fads, using maximum leverage to enhance buying power and buying more on the “dips”.

So it is no wonder that under these manufactured conditions, investors would “move out on the risk curve” — investor-speak for taking on more risk unconnected to expected returns. Most investors who say that they are willing to bear more risk do not actually mean that. What they really mean is that they fear missing out on the higher returns experienced by other investors — in other words, missing their benchmarks.

However, the ability of governments to protect asset prices from another downturn has never been more constrained. The global $30tn pile of stocks and bonds that have been purchased by central banks in order to drive up their prices has created a gigantic overhang. With inflation rising, policymakers are reaching the limits of their ability to support asset prices in a future downturn without further exacerbating inflationary pressures.

With all this in mind, it is puzzling that a growing number of otherwise sober money managers are in the process of boosting their allocations to riskier assets, rather than trying to figure out ways to make some kind of rate of return without giving back years of capital accretion in the next crash or crisis. Investors who have upgraded their risk levels, relying on policymakers to protect the prices of their holdings, may suffer significant and perhaps long-lasting damage when the government-orchestrated music finally stops.

Link to original FT piece

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There are multiple threads on the bogleheads of people trying to figure this out and as far as I know no one has.

I am willing to accept a negative real return on cash but I would have to pay a huge tax bite here in Taxifornia to sell stock with capital gains.

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Maybe you can hedge your risk without selling if you’re worried about a crash? If you’re long some index funds, short some SPY for large caps or IWM for small caps, etc. And just hold the dollar amount of the hedge until you’re willing to be long more again, so maybe you hedge 50% now or 75% or even 100% if you’re extra worried, and when that changes you can just cover some of the hedge. It won’t be perfect, especially if you’ve got a smaller number of individual stocks, but if you’re in mutual funds or ETFs, it should be quite easy to offset most of the risk very cheaply even for an ongoing period.

And if you’re more confident of negative returns, buy some puts on the indices/ETFs or calls on short ETFs.

Stock market yesterday reacting well to the FOMC meeting close and Powell’s extensive remarks and the press Q&A which followed.

Appears interest rates are not gonna rise at a rate stock market investors view as threatening.

Stock aficionados dodged a bullet. For them it’s:

Don’t worry, be happy. :sweat_smile:

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Low interest rates are generally constructive for equities, for the stock market, because they drive money out of safer investments, e.g. CDs, and into the market. Hence I believe:

Democrat administrations and Democrats generally are good for the stock market, at this time in particular. Here is why I’m thinking that way:

Both political parties today seek to spend money in order to curry favor with the electorate and “buy” votes. But the Democrats did this first and they do it better and more skillfully. By driving America ever further, hopelessly, into debt the Democrats place significant pressure on the Fed to keep interest rates low, lest our debt service not bankrupt the country even more quickly than is already a certainty at some future time. Such postponement of the inevitable, by the Fed, keeps rates low and bolsters the stock market thereby.

Credit for this mechanism goes in the main to Democrats. Their policies are underpinning equity prices, albeit perhaps via circuitous means. So if Republicans gain power in this fall’s election:

LOOK OUT!

And even the expectation of Republican power gains could be enough to spook the market. So it might not be necessary to await the outcome of the election to see this happen.

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The Fed is about to start raising interest rates in order to stave off inflation. This will begin well in advance of the next election, possibly as soon as March. I think we will see those effects on the equity market fairly shortly.

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Right. It’s happening regardless. The election will only tell us who gets retroactively blamed for it.

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This is certainly a possibility. But first they need to bring their bond buying to a halt and (God forbid) actually commence sale of those in their “treasure chest”. That “great unwinding” alone could negatively impact the stock market by driving up interest rates.

But it makes no difference to my earlier point how the Fed might choose to raise rates. Thing is thanks to all the debt, current and also future unfunded government obligations, the Fed is hogtied on rates and this mitigates favorably for equities.

Consider Chairman Volcker’s inflation fighting actions in the early 1980’s, when interest rates reached the exosphere. Were that to happen today the debt service on America’s massive debt would flush us down the toilet in short order. This goes double because so much of our debt today is short dated.

So to reiterate my earlier point, for all this debt we can in large measure (not entirely) thank Democrats. Regardless how much the Fed might want to raise rates to fight inflation, their options are limited. And the lower interest rates remain the better it is for equities. Hence, once again, Democrats are helping support the American stock market, albeit via circuitous means. This will remain true until the American economy falls apart completely beneath the weight of all that debt.

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just thinking about possible foreign policy fiascoes by the Biden administration scares the heck out of me. But by your reasoning, they represent buying opportunities.

Here are some possibilities:
Russia invades Ukraine
China invades Taiwan
Israel has to take out the Iranian nuke sites.
The fat man in North Korea decides to stir up trouble.

Thank you for your post, but I’m a little unclear. Could you elaborate a bit for us slowpokes, step by step, the mechanism you foresee benefiting the stock market in those several instances you have mentioned?

My thinking is that these events will cause a sudden sharp drop in the stock market. Assuming we muddle through, by your reasoning, stock prices have a tail wind and they will recover from the dips. Therefore, buy during the dips, which has worked for the past years will continue into the future.

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Thanks. If I understand correctly you are saying that, as a practical matter, nothing will derail the price of equities, not for a significant amount of time anyway.

While the Fed’s nominal mission is supposedly dual track, restrain inflation and foster full employment, I have believed for some time their de facto goal, above all others, is stock market price support. As such I have to agree no events such as those you listed will be permitted to upset the apple cart for long. Bottom line, it appears:

The fix is in!

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Source: Bloomberg article dated January 14th @ 3:29 am ET:

Europe Stocks Decline as Fed Hawks Spur Tech Rout

European stocks followed Asian shares lower on Friday after a slew of Federal Reserve officials signaled they’ll combat inflation aggressively. Treasury yields rose, while the dollar fell.

Technology companies, which are seen as most sensitive to higher rates, were among the biggest declines in Europe’s Stoxx 600 Index. U.S. futures ticked up after the Nasdaq 100 fell to its lowest level since October.

Fed Governor Lael Brainard said officials could boost rates as early as March to ensure that generation-high price pressures are brought under control, while Patrick Harker and Charles Evans joined the calls for higher interest rates this year. Investors will turn their attention to earnings over the next few weeks to assess companies’ performances amid soaring inflation, pandemic restrictions and backlogs.

“We are in a position where much that has been positive for equities is maybe moving to neutral or negative,” said Sarah Hunt, portfolio manager at Alpine Woods Capital Investors. “While there are still few alternatives, it makes the equity market ripe for more fluctuations over the next few months as we see how the data shake out and how the Fed reacts.”

Read entire article here

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The below is copied and pasted from an article I posted on the inflation thread:

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  • All major stock market indices traded below their 200-day moving averages on Friday as volatility soared.
  • A decisive drop below the widely followed technical indicator suggests more weakness ahead.
  • But there is little indication of stress in the credit markets that would point to a broader systemic issue hurting stocks.
    (Business Insider) .

The question is will the Fed step in to save the stock market as they have in the past?

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I hope not. My, previously all but dead, hedges are finally above water.

A good bit of weakness in the equity markets this morning. VIX is high, and of course stock prices generally remain very high.

So will all this angst be seen at some point as a fantastic buying opportunity?

Pay attention and stay tuned. This is becoming interesting. :wink:

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One data point is that the market (SP 500) is officially in correction mode having dropped more than 10% from its peak.

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