Co-Head of Investment and Group Chief Investment Officer at Schroders, Johanna Kyrklund, said there were three different types of “bears” running amok in the volatile global markets. For one type of bear, the market turmoil had brought some benefits. Investors had been pricing for the “Goldilocks” scenario, a moderate inflation and sustained economic growth, since the beginning of 2024. The recent market volatility has raised doubts about the possibility of a soft landing for the economy. The market performance was mainly driven by three types of investors, namely the three bears.
The first type of bear is the macro hedge fund industry, which has been affected by the unwinding of yen carry trades. The recent shift in Japanese monetary policy, as well as market expectations of a Fed rate cut, have weakened investors’ expectations of the US-Japan yield differential and led to the unwinding of these funds’ carry trades. The impact of these trades should soon disappear.
The second type of bear is the trend-following and systematic traders. They have executed the first wave of trades, which was mainly a response to the increased volatility in the markets. The first wave of trades is usually very fast and highly correlated with cross-system strategies. There may now be a second wave of trades, with signals turning, reflecting a change in trend, and a decrease in the correlation between different investment strategies. Analysis suggests that this group of investors is not yet fully out of the woods.
The third type of bear is fundamental analysis investors. These investors (including Schroders) tend to focus on medium-term performance and assess whether the risk of an economic recession has been appropriately reflected in the markets.
Johanna Kyrklund said that markets now expect the Fed to cut rates 5-6 times before 2024, each time by 25 basis points, which was beginning to diverge from reality and was more extreme. Schroders’ conclusion was that, as long as the credit markets (especially credit issuance) and the labor market remained stable, even if asset valuations had not fallen to the point where assets could be bought in large quantities without regard to economic cycle factors, the recent adjustments had eliminated some bubbles in the markets and improved the outlook for returns before the fall.