How institutional investors are navigating 2023
At the start of this week, Tim and I attended one of the most prolific hedge fund conferences in the nation (and no we didn’t have to pay $10k thank goodness).
We got to hear from billionaires like Paul Singer, C-Suite & Directors from Goldman, Citi, and JP, and the Chief Investment Officers of Apollo Management, Bridgewater, and other massive funds.
Here’s what they said about 2023 and how they are navigating:
Powell wants to go to “Fed heaven”
Federal Reserve chairs that fail to arrest inflation go to “Fed hell” according to Nathan Sheets, Global Chief Economist at Citigroup. With the job market going gangbusters (just look at the most recent jobs print) Powell has very little incentive to change his hawkish stance on interest rates. Investors expect the Fed Funds rate to stay high through 2023 and be the main headwind for asset returns. Anyone hoping for a Fed pivot will have to wait longer than expected.
Avoid duration
This was a constant theme, echoed by Wei Li, Chief Investment Strategist at Blackrock and Paul Singer, hedge fund manager and billionaire investor. The stubborn Fed and fading recession risks mean interest rates may remain high and volatile. Reducing exposure to interest rate risk by reducing bond duration is a solid trade in this environment.
Markets are euphoric
Jan Hatzius, Chief Economist and Head of Global Investment Research at Goldman Sachs, was the first to say that markets are “priced for perfection”. The S&P 500 has jumped 15% off its October lows, a move most lead researchers see as euphoric. Every manager had a different way to play this uncertainty, but the themes were low volatility, collared equity positions, and increasing exposure to value stocks.
Regime shift to supply-driven economic cycles
Atul Lele, Portfolio Strategist at Bridgewater Associates (the biggest hedge fund in the world), made a really interesting point during the market outlook. For the past two decades, economic cycles have been driven by demand. The ‘01 crash was driven by demand for tech stocks, ‘08 by the housing market. Supply was never really an issue until 2020. Lele sees a regime shift to supply-driven economic cycles, which is particularly risky because all of the Fed’s tools are designed to manage the demand side of the economic equation. If this happens, inflation will be much harder to tame. This is one of the reasons Blackrock (and Wei Lei) still favors inflation-protected bonds over nominal bonds for 2023.
Stock/bond correlation goes positive when inflation is in the picture
Normally, bonds and stocks have a very low correlation, which is the basis for 60/40 portfolio. As Morgan Stanley states, the 60/40 portfolio is not performing as well as it used to because stocks and bonds are becoming more and more correlated. David Zervos, Chief Market Strategist at Jeffries, blamed inflation for this change in correlation for 2022. Managers expressed a need to rebuild the 60/40 portfolio by adding alternative strategies like long-short and low volatility or new asset classes like commodities. Looking ahead, just having stocks and bonds in a portfolio is an incomplete portfolio.
Summary of Potential Portfolio Adjustments
Reduce duration in fixed income portfolios by targeting short-term, investment-grade bonds
Overweight sectors that benefit from stubbornly high interest rates (ie financials) and underweight sectors that are rate sensitive (ie real estate)
Increase exposure to inflation-protected bonds compared to nominal bonds
Diversify outside of the traditional 60/40 portfolio by integrating commodities, derivatives, or real assets into a portfolio
Overweight value stocks, implement a low volatility strategy, or collar equity holdings to hedge the risk of a market correction