Taylor Swift and the Stock Market May Have More in Common Than You'd Think
Have you ever passed by a car accident and had the unshakeable urge to look? That's how hedge fund managers feel about the stock market—knowing that retail investors are influenced by market sentiment provides a market for absolute return hedge fund strategies that frequently gather assets when the bear market shows up.
Think about it like this: when prices are up, we wish we had bought more. When prices are down, we think “I should have sold”—and as others start selling, the urge becomes stronger.
This predictable behavior is what economists refer to as reflexivity—the self-reinforcing effect of market sentiment, whereby rising prices attract buyers, and falling prices trigger a protectionist reallocation.
As the stock market closes in on a bear market year, and the Fed’s balance sheet continues to shrink, many investors are tempted to hoard their liquidity—does this mean you should too?
Strained Treasury Market
While the Federal Reserve’s balance sheet runoff gets underway, now at $95 billion per month, higher mortgage rates and a higher cost of borrowed funds will add to the drag on the economy, likely not to be reversed anytime soon. Some experts would suggest being careful as the carry trade—leveraging assets to buy more of the same—may be over.
Looking back from 2012 to 2021, the Fed regularly bought massive amounts of treasury and mortgage-backed bonds—driving bond prices higher and yields lower. This caused significant wealth creation and the incremental acquisitions of appliances and furniture that supported the robust home-building industry.
Conversely, the Fed is now suggesting that maturing bonds (commercial loans) will not be reissued. Rather, the liquidity is pulled from the economy, albeit at a current maximum of $95 billion blended roughly as two-thirds treasury bonds and one-third mortgage-backed bonds. The former multiplying effect of low interest rates, trickle-down stimulation and amplified economic activity is being reversed by diminishing economic activity.
To be clear, the Fed is discreetly telegraphing for this bond runoff to last approximately three years. Fed Chair Jerome Powell noted: “In times of heightened volatility or stress in the Treasury market, [the runoff] could carry the punch of nearly three typical rate increases, or about 0.74 percentage points.”
Stock Market Bottoms
David Rosenberg, former Chief North American Economist at Merrill Lynch who was consistently ranked by Institutional Investor as an “All American” analyst, frequently reminds investors that major stock market bottoms are forged when a 10-year treasury yield comes near to or equals the stock market’s yield.
In 1982, when the stock market bottomed, the Dow Jones P/E ratio was sub-seven. Today, we are at 19 times earnings. This is where Taylor Swift comes in—last month she became the first artist ever to simultaneously claim all top 10 spots on “Billboard’s Hot 100” list following the release of her latest album, Midnights. What am I getting at here? Sometimes the unthinkable happens.
What would your portfolio look like if the S&P 500 traded at a P/E multiple of 7, again? Recently, the yield on the exchange-traded fund “SPX” was 1.8%, while the 10-year treasury bond yielded 3.8% in late November. That gap may be closed by either security moving down or up in price, respectively, to find parity.
As we roll into 2023 with various headwinds—treasury debt runoff, macro environment pressures and a potential recession—ahead, now is a great time to sharpen your investment policy and implement strategies that align with your preference or aversion for risk.
Spartan Tip: Keep the Rule of 72 in mind when investing in new opportunities. This formula will help you calculate how long it'll take for an investment to double in value—just divide 72 by your annual rate of return. For example, 72 ÷ 8% annual return = 9 years.
Spartan Storage Fund 1—expected to close later this month—and Spartan’s private debt opportunities have probabilities of success married to the credit quality of the underlying security. Interested in learning more? Schedule a call with me to discuss these opportunities.