repositioning takes time

It has been very clear for a long time, let’s say June of this year at the very latest, that interest rates in the US were not going to go any lower, that the next major move would be to establish an interest yield on bonds that’s higher than inflation (this is normal), and that the first steps would happen before yearend.

With economic activity running stronger in the US than elsewhere, and supply-chain-problems creating unwelcome price increases, the Fed indicated during the summer that it would make these initial moves starting in November.

It seems to me that investors only began to seriously reposition their portfolios in reaction to the idea of a sea change in monetary policy in September, accelerating their activity in November and December.

You’d think that this would happen all at once. The ship captain sees the iceberg approaching and reacts by steering out of the way. But Wall Street doesn’t work that way. It makes one small change, followed by another, and then another …and then makes a final rush to do what arguably it should have done months before.

How so?

First, in 40+ years of watching the stock market, this little by little approach is what investors, professional and otherwise, do. As to why, I have no 100% satisfactory answer. I think part of it is like watching an engrossing movie in a theater and smelling smoke. The sensible thing is to get up and leave, but no one else is doing this and the movie is sooo good.

Part of it, also, is a reluctance to make all-or-nothing bets in a business where being wrong only 40% of the time is a winning performance. In addition, customers–or at least the consultants they hire to monitor performance–have no tolerance for a manager who sells ABC at $40, realizes this is a mistake and buys it back at $50 six weeks later. That gets you fired, even if the stock goes up from there. Selling it as an established dud at $30 doesn’t.

All in all, a very significant change like a reversal in direction of monetary policy probably takes six months of digestion before it’s fully baked into stock prices.

the yearend

There are only a handful of days left in pre-holiday trading. Institutional investors and market makers are already in the process of winding down operations. My sense is that because of this there are fewer potential buyers around than normal. On the other hand, there are lots of (taxable) retail investors, relatively price insensitive and only wanting to sell losing positions to establish tax losses for the current year. I think the combination results in wide swings in markets, with a bias to the downside.

the odd case of Cathie Wood

From its high in mid-February, the flagship ARK fund, ARKK, is down by about 40%. Over the same span, the S&P 500 is up by 19% and NASDAQ by 9%. This performance is almost as jaw-dropping on the downside as her epic relative–and absolute–gains last year were to the upside.

I was struck by a recent Financial Times article about ARKK in which a former boss of Wood’s is quoted as saying that, although a visonary, “…her biggest blind spot is managing risk and volatility.” What I understand this to mean is something like: if we were betting on coin flips, one bet is to wager $2 with a 50/50 payoff of $10; another is to wager $10 with a 50/50 payoff of $2. Wood isn’t able to distinguish between the two situations in her portfolio construction.

I have no idea whether this is true, although I do find it odd that she continues to double down on stay-at-home stocks like Zoom and Peloton (both of which I once owned and have long since sold). The point I want to make, however, is that no one normally says stuff like this about a rival. Added to crashing tech stocks, it makes me think we’re at or approaching another market inflation point.

more tomorrow