Top Managers See Market Risk Ahead
Each of us have our all-star lists, from baseball players to novelists to artists.
In the investing space, mine include Howard Marks of Oaktree Capital, Jeremy Grantham of GMO, Seth Klarman of Baupost, Paul Singer of Elliot Group and even that notorious bad boy of DoubleLine, Jeff Gundlach.
Yep—all hedge fund guys. And some of you may wince at the word “hedge fund,” but their platforms stand above the 12,000+ rest for a reason: they are good, very good, at what they do. Equally important: they understand market risk.
I’ve invested with some of them, studied others, but that’s not where my bias comes from– these guys are not only successful managers, but more importantly: legendary investors.
Bearish Feed-Back Loop?
So for this post, I wanted to step away from my direct bias on the markets and offer some indirect bias from the perspective of PM’s who I personally consider to be among the best in the world.
Sure, it’s a self-selected list, perhaps symptomatic of confirmation bias (we all tend to see markets the same), but bear with me, for their perspective is worth a look-see.
Back in February, for example, Baupost’s Seth Klarman, a notoriously private PM, came out of his otherwise low profile to raise some concerns about “perilously high valuations.” Much of his letter focused on the risk of naively assuming the “Trump Stimulus” of promised tax cuts, trade protectionism and infrastructure boosting would ever fly in the backdrop of US debt levels and balance sheet realpolitik.
That was in February, and since then, the “Oracle of Boston” seems to have been right…
Since then, and regardless of your political bend, DC seems to be swampier than ever, and loaded with distraction rather than action. This is political risk 101.
Klarman, like many other All-Stars, is concerned about investors hypnotized by the political talk of pro-growth policies. Since the election, markets are trading as if such growth was a reality rather than just a campaign promise. Any stimulus to come, Klarman warned, even if passed, would require adding to already high debt levels and a coming wave of potential interest rate hikes, which would balloon our shaky debt even further and put credit and equity markets—already dangerously high, at even further market risk.
Although Klarman is hoping for the best, he warned, “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”
This dangerous trio of politics, markets and media is real.
At the very least, Klarman anticipates greater volatility in this otherwise no-volatility Twilight Zone. Clearly with markets ripping, GDP stagnating and political chaos sky-rocketing, this low VIX surrealism does indeed feel like a Twilight Zone.
As discussed elsewhere and below, I feel we may see that volatility pick up in the Fall, as the debt-ceiling approaches and central bank policy tightens.
In any event, this Boston legend has raised concerns of market risk worth considering.
Switching coasts, let’s also consider the recent re-emergence of Howard Marks.
Unlike me, Howard tends to wait silently before publishing public rants on market risk. So when he starts to show concern, it’s worth a listen.
Admittedly, I’ve been worried about Fed-contorted market risk since 2013, and as a result have had to swallow a lot of pride as markets kept ripping (and the Fed kept stimulating) ever since.
Truth is, I was early in voicing my concerns—maybe too early. To my pathetic defense, I never imagined the central banks of the world would have the audacity to take money printing and low rates as far as they have to date, but they have—and as a result, I’ve got egg in the face.
What’s the adage? “Never fight the Fed?”
Despite my bruises, I still think the concerns are valid. The post-08 stimulus effect of $20T in collective central bank stimulus can easily blow these market highs to pieces, but as Marks himself stated, being right after years of waiting to be right isn’t really “right”…. And damn it, he’s right…
Few of us are able to time or predict the behavior of drunken central banks, for like all drunks, anything can happen on a binge—until it ends in disaster. In the interim, my search for possible triggers to send this artificially bloated equity and credit market into a tailspin have been suggestions rather than predictions.
For example, I thought maybe the fiasco in Greece would be a “Lehman Moment,” or maybe Brexit, or the Trump upset, or even the Fed QE taper in late 2014. But markets keep climbing on central bank steroids, phony accounting, and herd-minded cheerleading.
By the way, September could be a trigger, as we face interest rate moves, Fed balance sheet tightening and a debt ceiling all coming to an autumnal head. Am I a psychic? No. But there’s predictable market risk ahead—more risk to me than reward. That’s all I’m saying.
Meanwhile, I’ll keep whining.
But others are nervous too about market risk—and not just legends like Howard Marks or Seth Klarman. Jeff Gundlach has been raising cash and Eliot’s Paul Singer has been warning about Fed-induced market over-leverage as loudly, if not more, than even me…
Signals vs Macros
Meanwhile, I keep watching this tape in awe. It can go higher too, and for such short-term trades, I’m watching signals from cash flows, volatility envelopes and moving averages, not macro clouds. After all, one can still pick up dimes, even dollars, in front of this macro steam roller, but we still need to keep our eyes on the macros, the fall calendar and the yield on the ten-year, all of which I’ve discussed before.
What Mr. Marks is Saying
But when investors like Howard Marks start worrying and predicting, it’s probably another reason to pay attention, as he has a good track record of raising concerns not long before reality bites.
And Howard’s recently published a memo is worth repeating here. In it, he talked to clients about bullish trends going too far, about markets losing respect for risk aversion as equity bubbles blinded investors to otherwise neon-flashing warning signs of over-valuation.
Needless to say, I –and my many blog posts–agree. With stocks at all-time highs and the VIX at all-time lows—something is amiss… Market risk rises.
(Even the cheerleaders are starting to worry. Recently, JP Morgan’s top quant has been warning of a possible $100B market slide…)
In 2000, for example, when the dot.com euphoria had become as absurd as the NASDAQ’s PE multiples, Marks firmly raised an eyebrow and published an infamous warning. Other warnings came in the interim, but his next (and equally famous) memo of real concern came 7 years later in February of 2007, when he warned against misguided trends he was seeing. In both cases—2000 and 2007—his warnings proved eerily correct, as markets tanked shortly thereafter.
And now, it’s 2017 and Howard is worried again—and making no apologies for being cautious too soon. Why? Because being too soon is still better than being too late. His memo is fairly long, but I encourage all of you to grab a beer, coffee or OJ and read through his musings on cycles, bubbles and the unsustainable risk levels hiding in the backdrop of insolubility.
I think you’ll find his warnings on interest rates, central banks, geopolitics, technology and market bubbles both familiar and compelling.
Marks looks, for example, at a S&P trading at 25X LTM earnings and a Shiller Cyclically Adjusted PE Ratio at 30 (vs an historic mean of 16) and says: “uh-oh.” Furthermore, Howard makes a compelling case for interest rate moves and risks ahead. In short—take a read for yourself.
Perhaps afterwards, us market risk preachers won’t seem as chicken-little as we often appear…
Too Early vs. Too Late
In the interim, our Signals Matter trading signals are making money, for there’s still ways to trade this Twilight Zone. But voices like those of Howard, Seth, Paul etc. are right to remind us all that it’s far better worrying too early than worrying too late.
So don’t let these surreal market highs prevent you from thinking about risk management. As Scaramucci reminded us this week, one day you’re up, the next day your down…