A massive selloff in bonds. A plunge in tech stocks. The implosion of cryptocurrencies. The highest inflation in four decades.
Amid a brutal and uncertain climate, we asked six heavyweights in the world of finance to share their thoughts on the state of the markets, how they have handled this year’s carnage and what they anticipate in the future.
The market watchers disagreed on some fundamental issues.
best known for predicting the market crashes of 2000 and 2008, gave many reasons to be pessimistic even after the initial bursting of what he called “a super bubble.” Investing pioneer
the founder of Research Affiliates, agrees the market hasn’t yet hit bottom.
the former chief executive of Wall Street giant
Goldman Sachs Group Inc.,
says things aren’t as bad as they seem.
Most do agree this wild ride isn’t going to smooth out anytime soon.
Wait for peak fear
Investors should wait until markets have hit their bottom to buy, says Mr. Arnott. And that hasn’t happened yet, in his opinion.
Buy too early, and your investments will fall further. Buy too late, and you will have missed the best opportunity to make a profit.
U.S. stocks still look expensive to Mr. Arnott, the son of a pastor who turned a love of computers, math and research into investment advisory business Research Affiliates. He is known within his industry as the “godfather of smart beta,” a reference to funds that allocate money based on factors like companies’ dividend payments, sales, or volatility.
The problem is, identifying the moment of peak fear—when investors have gotten so pessimistic there’s nowhere for prices to go but up—almost always boils down to guesswork, Mr. Arnott said.
He is convinced U.S. stocks haven’t hit their trough. Why? The Shiller price-to-earnings ratio—a measure of the market’s overall valuation named after Nobel Prize-winning Yale economist
—shows that equities are still relatively pricey. The S&P 500 is trading well below its peaks during the dot-com bust and post-pandemic rally but far above the range reached during the worst of the 2007-09 financial crisis. That doesn’t seem to suggest that investors have reached the point of capitulation.
“I’ve been called a permabear,” he said. “But I’m a bear on things that are expensive. I don’t want to bother buying them, even if they could go higher.”
Things aren’t as bad as they seem
Mr. Blankfein, who steered Goldman Sachs through the brutal 2008-09 financial crisis, said the market’s outlook may not be as dire as many believe.
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“The bad news is so stacked up that people are under-appreciating the fact that there are several plausible pieces of good news that could affect the market positively,” he said, citing a change in Russia’s approach to the war in Ukraine, the release of more oil by Saudi Arabia and a pause in rate hikes by the Fed. “Markets are not just the current economy, they look ahead.”
This year’s selloff has been equally punishing for many stocks, he said. “Move into those you wished you owned but were too expensive.”
Mr. Blankfein said it’s worth remembering the challenges of the moment always seem worse than those of the past, if only because the past is resolved. And history, like the markets, has cycles.
“You think things have never been scarier?” said Mr. Blankfein, who retired from Goldman in 2018. “Really? We lived through the Cuban missile crisis when we were stopping Soviet ships in international waters. These are really the most polarized times? I was around in 1968 when there were assassinations of public figures, when kids were blowing up draft centers, and the National Guard was shooting on campuses. We got through that, we’ll get through this.
“It’s never as bad as your worst fears or as good as your best hopes,” he added.
Prepare for more chaos
Volatility is here to stay. That’s the view of
founder of investment firm Capstone Investment Advisors and someone who bets on haywire swings across global markets.
He expects rising interest rates to keep stoking turmoil, with few corners of the markets sheltered from the pain. Even bonds, typically thought of as a safer investment than stocks, have grown more volatile.
That makes many investors’ portfolios riskier than they appear, Mr. Britton says. The yield on the 10-year Treasury note, typically thought of as ultrasafe, has recorded some of its largest one-day moves of the past decade in recent months.
This turbulence, he said, means investors need to rethink what will buffer their portfolios and consider holdings beyond stocks and bonds. “The strategies that have worked best the past 15 years are not necessarily the strategies that are going to perform the next 15 years,” Mr. Britton said. “There is a structural shift that we haven’t seen in decades.”
At his firm, which oversees roughly $8.9 billion in assets and manages money for pension funds and endowments, Mr. Britton says he is particularly optimistic about a so-called dispersion strategy designed to profit from volatility. The complex tactic uses options to wager on how tightly stocks will rise and fall together.
“This is one of those moments in time where I think it’s crucial to be brave in your decision making,” Mr. Britton said.
Inflation isn’t going away
Investors are clinging to the belief that inflation will dissipate soon, says Nancy Davis, founder of asset management firm Quadratic Capital Management LLC, which oversees roughly $1.2 billion. They shouldn’t, in her view.
Inflation reached a four-decade high this year as the price of everything from groceries to gas soared. Federal Reserve Chairman
has made it clear he doesn’t expect that situation to change. He even abandoned the use of “transitory” when discussing the subject, saying roughly 11 months ago that ”it’s probably a good time to retire that word.”
“The Fed retired it, but the market is still pricing for transitory,” said Ms. Davis, who warned about the dangers of inflation in early 2021. “That to me is where there’s an opportunity.”
She cited the fact that inflation expectations among investors have been falling this year, even as data on consumer prices has shown continued gains. A widely-followed measure of investors’ annual inflation expectations over the next half-decade—the five-year breakeven inflation rate—stood recently at around 2.6%, according to Tradeweb. Year-over-year inflation is currently more than 8%, far above the Fed’s 2% target. This means investors expect inflation to tumble over the next five years, she said, and that bond-market investors may be too confident the Fed’s rate hikes will eventually bring inflation down.
She is preparing by holding mostly inflation-protected bonds and options tied to interest rates in the $1.1 billion Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund, where she is portfolio manager. These positions would serve as a hedge if inflation doesn’t subside, she said.
The ‘super bubble’ is still bursting
Mr. Grantham is legendary for spotting bubbles before markets crash. He did so in the lead-up to the tech-stock implosion of 2000, and before the financial crisis that began in 2008.
The co-founder of investment firm Grantham Mayo Van Otterloo & Co. gained renewed attention this year when he said U.S. markets were experiencing a “super bubble” in the very early stages of an ugly deflation. Nine months after that statement, Mr. Grantham remains deeply pessimistic.
“This is about as bad a package [of fundamentals] as we have ever seen,” says Mr. Grantham, who is board chairman and long-term investment strategist for his firm, which managed $59 billion as of June 30. Stock valuations, he says, remain well above their long-term averages. This is true even though economic growth has slowed, inflation has returned and interest rates have reversed after a long decline that had helped lift stocks for decades.
Mr. Grantham has put his own money in a family foundation that has allocated about half of its assets to young companies developing green technology, another 25% to other early-stage businesses and the remaining 25% to a few different investments, including one that benefits when the Nasdaq Composite falls in value and another that profits when investors see rising risk of corporate defaults.
For average investors, he says, holding cash is among the best options. He rejects the mantra that you shouldn’t try to time the market, pointing out several examples from history when it took years, or even decades, for markets to recover from crashes.
Bonds should bounce back
Bonds have had their worst year on record. That is one reason to be optimistic about next year, according to the man responsible for overseeing roughly $2.3 trillion in assets for the world’s largest money manager.
“I’m more excited going into 2023 than I’ve been in a really long time because we’re going to have so many different opportunities,” says
chief investment officer of global fixed income.
Investors typically value bonds with good credit ratings for their safe returns. Yet the Bloomberg U.S. Aggregate bond index has returned minus 16% this year—its worst-ever performance by far.
The problem: To fight inflation, the Federal Reserve has been raising interest rates at a historic pace and kept promising more ahead. That reduces the value of bonds issued when rates were lower.
Bond investors, Mr. Rieder acknowledges, have been hopeful before, only for more dismal inflation reports to further damage their portfolios. But he now sees clear signs that higher rates are starting to have their intended effect of slowing down the economy. That means that the Fed may not need to raise rates much higher than it is already projecting.
The good news for investors is that lower bond prices mean higher yields, or better forward-looking returns. That is true for old bonds that have dropped below face value and new bonds issued at higher interest rates.
With prices unlikely to keep falling like they have been, “you can feel pretty good about buying literally triple-A assets at these sort of yields,” Mr. Rieder says.
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