In his characteristic third-person style, One River Asset Management's Chief Investment Officer Eric Peters takes on all-comers in his latest letter to investors; lamenting the rapidity of losses, juxtaposing Michelle Obama's "hopeless" America with the US equity markets' near-record "hope", and denouncing the scourge of risk managers everywhere - central bankers...
Hope all goes well...
“No one has real risk on,” said the CIO, dizzy. “We’ve all been through the laundromat.” Equity long/short managers owned all the wrong stocks. And held the wrong shorts.
“We got tumbled.” But they’re not selling their darlings like Facebook, Google, and Amazon. In fact, they love those stocks even more at these prices. “The reflation names we were short we now want to buy.”
Financials, infrastructure, materials, etc. “So when you refuse to short your old longs, and want to be long your old shorts, what happens?” he asked, stumbling, peeling a static sock from his sweater. “Stocks go higher.”
“Now we’re feeling what not having hope feels like,” lamented America’s First Lady to Oprah, as another hopeful stock picker paid 22-times trailing earnings for the S&P 500.
“America needs a grown-up in the White House who can say to you in times of crisis, ‘Hey it’s going to be ok, let’s look at the future, let’s look at all the things we’re building,” continued Michelle. Infrastructure stocks consolidated their explosive gains, now up 40% for the year.
“All of this is important for our kids to feel like their work isn’t in vain, that their lives aren’t in vain,” she said, deeply upset, unsettled, like so many. Investors across the planet scanned screens in vain for a cheap Trump trade. But there are none. Unless of course, you hold high hopes for a brighter economic future.
“Our founding fathers built the Electoral College to safeguard the American people from the dangers of a demagogue and to ensure that the presidency only goes to someone who is, to an eminent degree, endowed with the requisite qualifications,” explained Martin Sheen, leading an absurd celebrity video appeal to deny The Donald.
Hopeless liberals squealed in echo chambers, victorious deplorables scoffed on Breitbart, Trump tweeted, Putin chortled, and the mighty greenback ascended to 14yr highs.
“At this point fiscal policy is not obviously needed to provide stimulus to help us get back to full employment, but nevertheless, let me be careful that I am not trying to provide advice to the new administration or to Congress as to the appropriate policy stance,” warned Yellen timidly, hiking interest rates 25bps for the 2nd time in ten years. And bond yields soared. As investors set aside their near universal disgust for the state of American politics to refocus on their job description. Which is to make money.
Where did all the risk go?
“Investors have outsourced risk-management to central bankers,” he said, pacing at the pension plan. We were discussing the challenges thrust upon large institutions by today’s new investment paradigm. They had built portfolios for secular stagnation, and awoke November 8th to something profoundly different. Trump’s victory marks a seismic shift from a world in which monetary policy was the sole driver of markets and economies.
Fiscal policy and corporate capital investment had been dormant for years. But no longer. Monetary, fiscal and corporate capex are all now active, competing, and conflicting in ways difficult to anticipate.
“Investors have relied on rate cuts and quantitative easing to truncate their potential losses,” he continued. “And in pursuit of unrealistic return targets they built highly diversified portfolios which gave them confidence to overleverage.”
Diversification is a wonderful thing in both theory and practice. Which is why it has been so universally adopted by large pension plans who must achieve 7% annualized returns or face insolvency. But when everyone adopts the same diversified asset class mix, and applies leverage, is diversification an illusion?
“As investment flows have converged around the same investment strategy, correlations have converged in a way that has generated self-reinforcing trends. But this makes the market highly vulnerable to correlation shifts.”
It is this risk that’s been truncated by central banks. But in the new investment paradigm, we can kiss our old correlations goodbye. Will the Fed ease aggressively to reverse a stock market decline in the midst of a major fiscal stimulus? “In the end, markets conspire to create diversity. Models do not become the market. Markets don’t converge to a common DNA. That’s where we find ourselves today.”
And he paused, sighed. “Until we feel real pain, as a group I’m sure we won’t change. But our industry must re-introduce risk management strategies.”