Back on November 1, we reported a “fascinating statistic” by Deutsche Bank – as of the end of October, 89% (a number that has since risen to at least 90%) of most major global assets had a negative total return year to date in dollar terms. This was the highest percentage on record based on data back to 1901, eclipsing the 84% hit in 1920. Putting this in context, in 2017 just 1% of asset classes delivered negative returns. The final straw was when the S&P 500 index, which had valiantly resisted a negative return for the year, finally succumbed to the gravitational pull of most other markets and turned red last week when it also suffered its second correction of 2018.
And while this statistic was quietly ignored for much of November, it eventually made its way to the front page of the WSJ today – just days after the S&P turned negative for 2018 and slumped into its second correction of the year – which reported what most traders had known already: “stocks, bonds and commodities from copper to crude oil to burlap are staging a rare simultaneous retreat, putting global markets on track for one of their worst years on record and deepening a sense of unease on Wall Street.”
For those investors who have somehow slept through the past two months, it has been a painful market ever since the S&P hit its all time high on September 20: major stock benchmarks in the U.S., Europe, China and South Korea have all slid 10% or more from recent highs. Crude oil lost a third of its value and slumped deep into bear market territory, emerging-market currencies have broadly fallen against the U.S. dollar, while bitcoin’s price crashed below $4,000 over the weekend amid what a broad risk capitulation.
While havens such as Treasury bonds and gold rallied this fall as riskier assets swooned, both are still down on a price basis for the year, reflecting trader concerns with solid economic growth and tighter Federal Reserve policy that have begun to push interest rates out of their post-financial crisis doldrums.
And, as we first discussed last week in why “Nothing is working“, the market’s sharp and broad pullback has left fund managers scrambling to find places to park their money. But with global growth showing signs of slowing even as monetary policy is expected to tighten further, few are eager to place large wagers and risk compounding earlier failures to generate expected gains.
The reason: as the WSJ notes, “the simultaneous failure of so many investment strategies is being by viewed by some as a warning of what could come following years of above-average returns.”
For professional asset managers there is a silver lining: virtually everyone else is also hurting.
“It’s been a difficult year,” said QMA chief investment strategist Ed Keon. “All investors have goals, and none of those can be fulfilled with negative returns.”
Paradoxically, while virtually nobody believes that a recession is imminent – with consensus expecting the US economy to shrink in 2020 at the earliest – the strength of the U.S. economy in the face of a global slowdown has prompted the Fed to keep rising rates, much to the chagrin of Donald Trump, and shifting ever further away from the regime of rock-bottom interest rates and bond-buying put in place after the financial crisis. As a result, rising short term rates, and the highest real 10Y rates since 2010, have diminished the premium investors get for taking on risky assets, pressuring virtually all markets.
The recent plunge in asset prices has been especially crushing to those who expected the upward momentum and asset levitation for much of the year to continue and doubled down on the recent swoon. One such example is commodity hedge-fund icon Pierre Andurand, who earlier in the year bet oil could soon hit $100 a barrel (and even said $300 oil is “not impossible“), but has since watched as his $1 billion Andurand Commodities Fund suffered its largest monthly loss ever in October, and November isn’t looking much better with the oil plunge accelerating.
Meanwhile, believers in “growth narratives” have been trampled by a furious rotation out of growth and into value as funds that had built up massive stakes in fast-growing technology companies were crushed by sharp reversals. Twenty-six funds dumped their entire stakes in Facebook Inc. in the third quarter, according to a Goldman Sachs Group analysis of 13F filings, including billionaire Daniel Loeb’s Third Point LLC, which offloaded 4 million shares, citing “a very disappointing quarter” for Facebook.
Adding insult to injury, the most shorted names across the hedge fund space have seen periodic squeezes that have forced dramatic short covering and led to even more losses.
The result has been one of the worst years for hedge funds since the financial crisis: the Goldman equity hedge fund index is down 4% YTD, underperforming the S&P by 6%, even as the basket of most shorted names – a testament to just how painful the short squeezes have been – has outperforming the broader market.
Underscoring the dreary environment for hedge fund managers, the Goldman Hedge Fund VIP basket of most popular hedge fund positions, has been in freefall ever since hitting a high earlier in the summer.
Still, some investors refuse to accept the creeping fear that the bull market is over (last week Morgan Stanley was quite clear on the matter, declaring that “We are in a bear market“) and contend the market’s 2018 stumbles are a good sign, and that the declines across across all asset classes that had finished last year in the green reflect a “healthy” correction if a painful readjustment of expectations.
“A year like this—it shakes out some of the situations that were out of kilter with the rest of the economy,” said Jason Pride, chief investment officer for private clients at The Glenmede Trust Co. After markets around the world soared to records last year, buoyed in part by synchronized global economic growth but also by a surge in investor optimism, “we actually needed to take some air out of the system,” Mr. Pride said.
Pride is unwilling to throw in the towel and like others, is betting the bull market in U.S. stocks still has longer to run before the economic expansion morphs into a downturn. While U.S. economic data have been bumpier as of late, with the housing and auto sectors in particular showing signs of strain, the overall picture still looks solid, Pride told the WSJ.
Even so, Glenmede concedes it had to turn down its recent euphoria, and last year the fund began paring its exposure to some of the fast-growing technology stocks that had run up sharply, betting their outperformance would fade. The decision was widely criticized at first, but has since seen the approval of investors:
“The feedback loop felt horrible—absolutely horrible,” Pride said, recalling presentations he gave where some clients questioned why the firm had pulled out of stocks that had rallied more than 50% in the past year. That decision has seemed easier to justify more recently, with many former big hitters such as Facebook, Apple Inc. and Netflix Inc. tumbling, he said.
Other advisors have similarly urged their clients to stay invested but add to downside hedges. UBS Group’s wealth-management arm has urged its wealthy clients to keep their S&P 500 long, but to start using puts to protect against further pullbacks.
“We’re cautiously optimistic,” said Jerry Lucas, a senior strategist at UBS Global Wealth Management’s chief investment office. “It’s worthwhile to be a little more conservative and have some hedges on to reduce your risk.”
Whether this cautious optimism is justified will depend on just one person: Fed chair Powell, who is increasingly expected to relent in his hawkish pursuit of higher rates. If not, and there are few indications to suggest the Fed will concede and appear to fold to pressure from the US president who has been urging the Fed to end its tightening ways, what has been a dismal 2018 may mutate into a disastrous 2019.
Minneapolis Fed President Neel Kashkari, one of the Fed’s biggest doves who has frequently called for a stop to raising interest rates, repeated his warning and said further tightening could trigger a recession: “One of my concerns is that if we preemptively raise interest rates, and it’s not in fact necessary, we might be the cause of ending the expansion” and triggering the next recession, Kashkari said in a National Public Radio interview posted online last week.
Which, of course, will not come as a surprise to regular readers who know very well that every single Fed tightening – like the one right now – has resulted in a crisis.
Thomas Poullaouec, head of Asia Pac at T. Rowe Price in Hong Kong, summarizes the above perfectly with the following brief assessment: “It hasn’t felt like a bad year, but retrospectively, it’s been a pretty miserable year. 2019 isn’t looking to be any better either.”