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What Sayeth the Deep Pockets?

AInvestFriday, Aug 16, 2024 5:31 pm ET
4min read

We've seen a lot of volatility over the past two weeks. In fact, it was just a cluster around roughly 3-4 days, with one day (last Monday, August 5, 2024) playing center stage as a very headline-grabbing affair on The Street.

As we recently covered, this dive was prompted by a coalescing "perfect storm" conjunction of several forces:

  • Increased fears of a hard landing and near-term recession due to Powell's Federal Reserve falling behind the curve with interest rate adjustments,

  • The shift into a tightening regime at the Bank of Japan, sparking a sharp rally in the yen versus the dollar, triggering a pinch for the yen carry trade, which funnels massive streams of leverage into the financial system powering the risk trade across asset classes,

  • Concerns about the reliability of future estimates for AI chip sales, particularly in terms of timing, driving further concerns about a cyclical downturn in the chip space,

  • The standard refrain of valuation fears often seen after momentum stalls following a strong bull market rally.

  • There were fundamental, mechanical, financial, and thematic dimensions involved, and they all played their part.

    However, today, we are going to focus on trying to get a better feel for where big-money fund managers stand on these catalysts and issues as we prepare for Jackson Hole and a potentially pivotal FOMC meeting in September.

    I make the case that the composite image we arrive at just after the midway point in the year could pace us for a similar market dynamic as last year, with pessimism growing into late October and then a stockpile of underleveraged dry powder meets November with nowhere to go but to chase benchmarks in a holiday sprint to close out 2024.

    Fund Manager Economic Sentiment

    One interesting survey question is: What would you most like to see companies do with their cash flow at the current time?

    The three predefined choices were: increase capex spending, improve balance sheets, and return capital to shareholders.

    A graph of a company's companyDescription automatically generated with medium confidence

    The current moment is particularly interesting because this is the first time in over 12 years where "increase capex spending" came in last place (24%). It was also the highest vote total in 11 years for "return capital to shareholders" (28%). Improve balance sheets was #1 at 40%.

    In other words, no matter what else you hear from big money managers, their view on the cycle is clearly that it's no time to make fresh investments in expansion. Shore up the fortress walls to prepare for a storm. And distribute what's left to us.

    In other words, this is a late-cycle philosophical marker. But that hardly means they're right. The last time we saw something similar was on the doorstep to a cycle acceleration in 2013-2014. That said, the push to favor improving balance sheets has been a big theme since the pandemic, first due to the illiquidity, then due to the rising costs of refinancing as the Fed moves rates higher.

    Note: Other items back this up as well, including the fact that 74% of respondents expect a weaker economy over the next 12 months. 

    This is also the first time in 2024 that we have seen Recession cited as the biggest tail risk for investments.

    A graph of a graph with numbers and textDescription automatically generated with medium confidence

    Finally, the August 2024 FMS set a new all-time record for expectations for lower short-term rates. This goes along with my recent piece suggesting that the Fed may have to cut by as much as 200 basis points just to get back down to a neutral rate.

    One can see all of these as either economic skepticism or concerns about a policy error from the Fed. If the latter, then a quick process of resetting from the Fed could re-energize economic sentiment if it isn't already too late.

    Backing up this last point, a net 55% (so, a nominal 78%) see Fed policy as too restrictive—the highest since 2008.

    A graph of a global monetary policyDescription automatically generated

    Fund Manager Positioning

    Another interesting question posed to fund managers in the survey was: What level of risk do you think you are currently taking relative to your benchmark?

    This is another item that lines up a bit in the "soft bear" camp—self-assessed risk is at a new 7-month low.

    A graph of a stock marketDescription automatically generated

    In fact, a net 19% said they were taking less than typical risk with portfolios. That un-deployed risk is effectively dry powder storing up.

    Part of this is about valuation. To wit: the vast majority of respondents still see the Magnificent Seven stocks as, collectively, the most crowded trade on The Street.

    Part of this is also a bit of a logical trap. As you can see, while they see the Mag-7 as an overcrowded trade, they also see "large-cap growth" as by far and the away the most productive factor bet available.

    A graph of stocksDescription automatically generated

    In other words, the epitome of "large-cap growth" is where you want to be, but that's also an area you see as overcrowded. It's a conundrum, and one that has clearly eroded risk-taking tolerance among large managers, especially as they see the Fed sitting too tight during the seasonally weakest period of the year for equities.

    Conclusion

    If one were to try to mockup a composite image of "the average large fund manager right now", one ends up with an increasingly economically skeptical person—increasing unhappy with the Fed's unwillingness to get ahead of the curve and reduce the gap to r*. 

    It's someone starting to lose faith in the concept of the soft landing. Someone rotating into bonds, cash, and healthcare as defensive positioning. Someone who thinks the future is large-cap growth, but sees that as overcrowded. 

    It all adds up to someone with an increasing pile of dry powder storing up and less risk on the table. 

    Make of that what you will, but it smacks of a late-year rally if perceived odds of a soft-landing increase as election uncertainty falls off the page in late October and early November while the Fed maintains a commitment to further policy easing.

Disclaimer: the above is a summary showing certain market information. AInvest is not responsible for any data errors, omissions or other information that may be displayed incorrectly as the data is derived from a third party source. Communications displaying market prices, data and other information available in this post are meant for informational purposes only and are not intended as an offer or solicitation for the purchase or sale of any security. Please do your own research when investing. All investments involve risk and the past performance of a security, or financial product does not guarantee future results or returns. Keep in mind that while diversification may help spread risk, it does not assure a profit, or protect against loss in a down market.