Reuters
- A few hundred Wall Streeters met in the Cayman Islands last week as the market was melting down.
- No one could stop talking about the newest feature in global markets — fear of the unknown.
- The market is morphing into a more volatile creature. Some investors will get it, and some will be winnowed out.
Last week, a few hundred terrified Wall Streeters met in paradise as the market weighed (and howled at) the prospect of a swiftly changing global economy.
“The world has not ended. The market will be back. Stay true,” Caryle Group cofounder Daniel D’Aniello said as he wrapped up his talk to shell-shocked money managers at the Cayman Alternative Investment Summit in the Cayman Islands.
Of course, D’Aniello was right — but his comment was beside the point. No one in that room of professionals was afraid because they felt the market had gone away. Instead, their great fear was and is that the market that will come to exist in the aftermath of last week’s violence will be unrecognizable to them.
In the last 10 years, the “wolves of Wall Street” have become much more like passive house cats, living easy lives going long the market and watching money grow in a friendly bull market world created for them by central banks in the wake of the financial crisis. They have forgotten that their nature was once to roam in the wild, to hunt and kill.
But that all has to change, now that volatility has come back to the markets and the future of the economy is more uncertain.
And what dominated conversations between beach cocktails at the Kimpton Seafire and one-on-one sessions with Will Smith, Danica Patrick, and Sophia the Robot was the existential Wall Street question — am I cut out for this?
“Certainly managers have done well with the volatility and some haven’t,” Elise Rosenberg, a director of capital solutions at Barclays, said on a panel on “100 years of hedge funds.” That comment elicited some weak laughter, and she continued.
“You just have to be prepared.”
Young again
Nothing better illustrates this changing of the guard than the first line of an investor letter that floated around Wall Street last week. The letter was written by Paul Tudor Jones, an embattled but legendary macro trader.
In the last few years of market placidity, men like Jones who cut their teeth on the wild market swings of the 1970s and 1980s have been neutered — forced to lower their fees and return money to investors as the lack of commotion made it harder for them to generate returns.
“I feel like I’m in my 20s again,” Jones wrote.
That is to say, what’s old is new again. In the letter, he warned that policymakers are making the same mistakes he saw their counterparts make in the 1980s. The Federal Reserve, he said, is putting too much emphasis on stoking inflation and ignoring dangers arising in household and corporate debt, fueled by low rates.
And then there’s the Trump administration. Jones blames the weak dollar on its complete and total lack of fiscal responsibility, which is further stoking inflation fears.
From the letter:
“‘And just as I promised the American people from this podium eleven months ago, we enacted the biggest tax cuts and reforms in American history.’ – Donald Trump, State of the Union Address 2018
“This statement probably brought the loudest cheer of the night this week as all the Republicans jumped to their feet and offered a chorus of huzzahs. No doubt the tax cut has had a profound impact on the economy in the short-term and that will continue. But I wonder if they would have remained cheering if President Trump had followed with, ‘By the way, Treasury auctions will increase this year from the current projection of $583 billion to almost $1 trillion. Relative to recent auction sizes, Treasury auctions will be higher by $500 billion next year and by $545 billion in 2020.
“‘And, secondly, the Congressional Budget Office’s long-term projection for our debt/GDP will eclipse that of Japan at its peak, possibly making us the most indebted country in the world by 2033.’ For those of you not old enough to remember, one of the most popular phrases of the 1970s and 1980s was ‘crowding out.’ Get used to it as it describes the detrimental effects excessive public sector borrowing has on the economy, which will become more popular as time progresses. This is all simply breathtaking. It is incredible that at full employment we have passed a tax cut that will push our deficit to 5% of GDP. Can you imagine what will happen to the deficit and debt in the inevitable downturn? This is what the dollar is sensing.”
Right now, thanks to the return of inflation, the market is weighing a new set of possibilities, some of which include complete and total chaos and an economic downturn prompted by rising interest rates. This risk calculation is a process — one that Jones doesn’t think is over. No one in the crowd of endowment heads and allocators in the Cayman Islands did either.
“The bottom line is that the upside risks to US rates are significant as a result of higher US inflation and likely weaker demand for US Treasuries. I now have clients asking me what the probability is that US 10-year rates will hit 4%,” Deutsche Bank analyst Torsten Slok said in a note to clients as the market pacified on Monday. “Watch carefully how equities and credit spreads perform as we get more evidence of higher inflation and evidence of weaker demand at US Treasury auctions.”
Winners and losers
And it’s not just talk — there are already winners and losers emerging from our new, more uncertain world.
Over the next few weeks you’ll see a particularly Wall Street genre of stories in the press — the “they saw it coming” stories of investors who made perfect bets on this violent market move. Here’s one about some guys in Denver making a killing betting against a popular short-volatility trade that blew up in last week’s market chaos.
Kudos to them, they’re in an exclusive group — most people didn’t catch this falling knife. Take the California Public Employees’ Retirement System (CalPERS), for example.
From Yves Smith over at Naked Capitalism:
“CalPERS under its chief investment officer Ted Eliopoulos has been too clever, in a bad way, over the last eighteen months. It cuts its allocation to US stocks just before Trump took office, getting less benefit from that rally than it could have. CalPERS has had a 50% allocation to foreign stocks for years, betting on a weak dollar environment when the dollar has been strong. It cut its foreign investment targets, and if my recollection is right, not long before the dollar started to weaken.”
Even the great Ray Dalio of Bridgewater Associates was blindsided. He told attendees at the World Economic Forum in Davos on January 23 that: “If you’re holding cash, you’re going to feel very stupid.”
Life comes at you fast.
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