We like to think of the market moving in a variety of ‘herds’, with the opportunities for the biggest herd, the long term investor, being presented by the behaviours of the other two, the Asset Allocators and the short term noise traders. As we have previously noted, short term traders are focused on upside, often using a lot of leverage and use the narrative to encourage others into their trade and allow them to exploit that flow. For want of a better term, they are about the emotion of Greed. Asset allocators by contrast are largely about the opposite emotion, Fear. With little leverage at work, their primary focus is on not under-performing their benchmarks. They care mainly about minimising downside relative to a benchmark. As such, when uncertainty increases, they will tend to flatten their exposures to match the benchmarks and they can also be relied upon to deliver a degree of passive flows into stocks and sectors that are rising and out of those that are falling, making for a semi permanent momentum feature in markets.

The idea that the market ‘knows’ something that you don’t (and you should sell/buy on that basis alone) is actually a major reason why retail investors underperform and goes to the heart of Ben Grahams’ concept of the ‘manic depressive’ Mr Market . Essentially Mr. Market, (as wikipedia puts it),

• Is emotional, euphoric, moody
• Is often irrational
• Offers that transactions are strictly at your option
• Is there to serve you, not to guide you.
• Is in the short run a voting machine, in the long run a weighing machine.
• Will offer you a chance to buy low, and sell high.
• Is frequently efficient…but not always.

Thus we derive concepts made popular by Warren Buffet and others such as “if I liked a stock yesterday at $1, why should I like it less when the market offers me the chance to buy it at 90c?” Of course, to be ‘buying when others are selling and selling when others are buying’ requires that the investor believes they have some insight into why others might be selling the stocks that they like and obviously that requires that it is not the stock fundamentals themselves.

Different aspects of the market are all ‘Telling their own truth’

Our view of herds means that we would disagree with the concept of markets being inefficient – they work efficiently but with different aims for different groups. Nor do we see them as irrational, rather that the different market participants are, to coin a fashionable phrase, “telling us their own truth”. If a leveraged trader is being forced out of a position, or an asset allocator is buying an area of the market that they are underweight in case it goes up and makes them underperform, then the narratives, the stories they tell themselves to justify these moves, are indeed ‘true’. They believe them and they act on them, but this doesn’t mean that the long term investor must also act. When narratives flip from positive to negative it is all too easy to justify reducing risk as much as possible, but the (painful) lesson for investment managers is that reducing risk will similarly reduce return. This is not about trying to be too clever in ‘timing the market’ – after all, as the old wealth management expression has it, it’s time in the market (i.e buy and hold) rather than timing the market that delivers returns – but in recognising that the best risk return ratios are often achieved when you buy the things you ‘like’ at the point when other people are being forced to sell them.

Thus, as the short term traders have dumped their leveraged tech holdings and moved off to chase the inflation/reflation narrative in the Commodity markets and as the asset allocators look to get their positions set in time for the Triple Witching on Friday, the question for long term investors is essentially ‘which dip to buy?’

For Equities, this brings us back to the notion of the 5 C’s that we first looked at back in November when we discussed the concept of a Great Portfolio Reset . To recap, the 5 Cs were CashFlow, China, Convertible Bonds, Commodities and Crypto Currencies. The rationale for buying in these areas has not changed and would warrant putting any cash on the sidelines to work, especially if some distressed selling means Mr Market is offering these assets at more attractive valuations than a month ago (if not at the levels seen in November). We would, however, be wary of chasing broad groups on the narrative basis that ‘when the yield curve or any other macro variable does x, then financials (or bond proxies or any other broad grouping) does Y, for while doubtless some of the quant models have an inbuilt assumption that markets repeat themselves, our experience is that these work, at best, only for trading. The past experience only repeats for a brief period as the models rotate in, before the fundamentals ‘get in the way of a good story’. Stocks within broad groups that have strong cash flows, exposure to Asia/China or commodities may well represent good risk return if they have currently been sold down on the basis of a broad group characteristic and thus will benefit from both the short term rotation and the long term inflows, but ones that do not have attractive fundamentals will find their uptick short lived.

For Bonds, the macro noise traders will doubtless be getting excited about the Fed on Wednesday, but they clearly are not going to repeat their interventions from this time a year ago. Remember that the Fed intervention straight after Triple Witching effectively marked the bottom of the equity sell off but as we noted at the time also did very nicely for both BlackRock (BLK) and BlackStone (BX), (see Back to Black, Rock Stone). This was because the intervention was not to save the Bond market, but to save the Bond ETF complex. As Chart 1 shows, both companies are up sharply from the March lows and over 30% even from January last year, compared to the S&P at plus 21%. Moreover, as also shown in chart 1, the Long Bond ETF (TLT US), having initially rallied on the Fed intervention is now sharply off its highs and is actually lower than before Covid.

Chart 1: Fed Intervention good for Blackstone and Blackrock rather than Bonds

As such, in contrast to equities, we struggle to see the case for buying the dip in bonds at the moment – our risk indicators for all except high yield are all sitting at the sort of (high) levels that Equities were at last February, while by contrast Equities look more like bonds did back then. Indeed, we suspect that we may well have (finally) entered a bond bear market, characterised as ‘sell the rallies’ rather than ‘buy the dips’, in which case long term investors will be steadily leaving the party. Maybe not, but certainly for now our risk models are out of everything except high yield, suggesting that currently it is a time for watching bonds from the sidelines.

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