Smart money still wary of stock rally

Regardless of what the conspiracy theorists tell you, no one microchips your brain at the World Economic Forum registration desk in Davos to ensure perfect harmony of thought.

The microchips may have been inserted this year at the Global Collaboration Village, a “metaverse with a purpose,” just down the main street from the conference center, but sadly, this correspondent’s schedule didn’t allow time to find out.

Yet the consensus around the direction of global markets in the comfortably carpeted halls of power at this month’s annual meeting was surprising. In short, the thinking among serious money managers is: don’t buy the hype.

Markets have certainly started 2023 on a high note, with the MSCI World Stock Index gaining around 6 percent before January even ends. That takes the gain from the low point in October to a staggering 20 percent.

Not for the first time, this is fueled mainly by the hope that inflation seems to have come down and that therefore the US Federal Reserve might be willing to cut, then stop, and even potentially reverse the interest rate hikes that broke out in many fund managers’ returns last year. Futures markets show traders see a probability close to 20 percent rate cuts by the end of the year.

Just because this narrative has been wrong on multiple occasions since early 2022, it isn’t necessarily wrong now. But it was hard to find someone in the Swiss Alps to buy it.

Nicolai Tangen, head of Norway’s massive $1.3 trillion oil fund, is among the spoilers. With a dash of Nordic candor, he told me about the bubbly market conditions that stemmed from the global injection of monetary stimulus after the Covid outbreak had caused a lot of “crap” on stock markets. He said the oil fund’s performance in 2022, down 14 percent overall, was one of its worst stretches since inception, but it would have been worse if it hadn’t decided to avoid some of those new listings on the market.

Now, Tangen said, much of the froth had lifted from markets, but investors should accept that the Fed may well restart rate hikes and a long, slow grind of low yields lies ahead.

Again, with or without the mind-controlling microchip, big money managers agree that this is a likely outcome that many investors are reluctant to accept. Investors generally know that this time is different, that 2022 taught everyone that they didn’t understand inflation after all, and that the Fed can stay hawkish longer than you can stay solvent. However, they are still struggling to get rid of the muscle memory accumulated in previous cycles.

“We think we’re changing from a kind of environment that’s been around for more than 40 years,” said Karen Karniol-Tambour, co-head of investment for sustainability at Bridgewater Associates, the hedge fund giant. “We think we are moving towards an environment where inflation will be more volatile, more entrenched.”

That will require monetary policy to be tightened for longer, even despite the damage this may inflict on the real economy and employment.

“The market has had a couple of months of saying ‘maybe we’ll be back to normal, don’t worry,'” Karniol-Tambour said. “We don’t think that’s right.”

Bridgewater’s flagship Pure Alpha fund produced a 9.5 percent gain last year, roughly in line with its long-term average and a performance asset managers can only dream of. The increase could have been larger if Bridgewater had chosen to join the market rally in the fourth quarter. Instead, he stuck to his view that the impact of the already aggressive rate hikes has yet to play out and that markets are overly bullish.

Jonathan Hausman, senior managing director of global investment strategy at the $250 billion Ontario Teacher Pension Plan, is relatively optimistic. For OTPP, the answer is to try to look beyond the short-term conflicting signals and look for longer-lasting bets in infrastructure and real estate. It may sound boring and basic, but bonds, both corporate and sovereign, are also more attractive prospects now that yields have risen and default risks still look low.

But he also agreed that investors are working hard to convince themselves that markets are in recovery mode. “The mood is schizophrenic,” she said. “Among scholars, there is a feeling that the institutions, the Federal Reserve and the European Central Bank, are really in it for the long haul, not to be the ones to let inflation break out. Your heart says ‘I think this is going to be okay’ but your head says ‘I know these guys are playing forever’.”

As 2022 drew to a close, the idea that central bankers could stifle a resurgence in markets this year was seen as a small possibility, an extreme, high-impact risk. But it is clear that the smart money is taking this perspective seriously. If you rush headfirst into this rally, this should be enough to bring you to a stop.

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