The once-hot Wall Street trades of 2023 are all falling apart, in a fresh blow to market pros blindsided again and again ever since the pandemic broke out.
Nearly halfway into the year, a slew of consensus bets is losing big time as the US economy defies the recession bears, the artificial intelligence craze heats up, and more.
Misfiring strategies include selling Big Tech stocks, snubbing the dollar, and buying into the promise of emerging market equities as China emerged from Covid lockdowns. Instead, US growth shares are on the cusp of a full-blown melt-up, while Chinese stocks sink into a bear market. Rather than falling, the greenback has strengthened, including a 6% surge versus the Japanese yen.
Those betting equity returns would be dwarfed by fixed income — in part, thanks to one of the best payouts in decades — have also been wrong-footed. The MSCI index tracking global shares is up 10%, compared with a gain of 1.4% from bonds worldwide tracked by Bloomberg.
It’s the latest setback for conventional wisdom on the Street, flummoxing sell-side strategists and macro hedge fund managers. From endless inflation to the great bear market of 2022, getting a grip on investing and economic trends has proved exceedingly difficult over the past three years.
“Investors underestimated the growth profile of the US and overestimated the pace of recovery in China,” said Mark Freeman, chief investment officer at Socorro Asset Management LP. They “did not have AI on their radar at that point, which has easily been the biggest factor driving the markets.”
So far in 2023, backfiring bets are making life difficult for macro-focused fund managers such as Said Haidar and Chris Rokos amid extreme volatility in US government bonds. An index of macro/CTA funds tracked by HFR is down 0.2%.
The pain is particularly acute for investors who have shunned stocks in favor of bonds, worried aggressive Federal Reserve monetary tightening would derail the world’s largest economy. In a December survey of fund managers by Bank of America Corp., government bonds were forecast to be the best-performing asset in 2023, and allocation to fixed income stood at the highest level since April 2009 versus equities.
In the US, Treasuries have advanced, but they’re way behind stocks. Trailing by 7 percentage points in the first five months, government debt is off to the second-worst start of a year in a decade relative to the S&P 500.
Fueling the surprise equity outperformance is the optimism around AI following November’s release of ChatGPT. The frenzy has sparked a surge in shares of computer and software behemoths, with the seven largest tech firms like Microsoft Corp. and Nvidia Corp. accounting for almost all the market’s gains.
AI euphoria, along with better-than-expected corporate earnings and economic data, has helped US stocks to tune out recession alarms from the bond market — and warnings from the likes of Morgan Stanley’s Mike Wilson that the S&P 500 would hit fresh lows in the first half. The benchmark index has climbed 19.8% from its October bottom, approaching what’s commonly defined as the threshold for a bull market.
That’s bad news for pros, who according to BofA’s survey cut their exposure to US equities to a 17-year low at the start of 2023.
“AI has taken off like a rocket and drawn all kinds of investors in,” Tony Pasquariello, Goldman Sachs Group Inc.’s head of hedge-fund coverage, wrote in a note. “There are still detectably strong and fairly widespread expectations of a US recession” for the next 12 months, he added. “That view — if more psychological than currently positioned for — has been challenged by the recent macro data set and equity market price action.”
Meanwhile, enthusiasm for China proved misplaced. In January, growth expectations for the Asian economy hit a 17-year high while allocation to emerging markets including China climbed to levels not seen since June 2021.
Now, an MSCI index tracking stocks in developing nations is behind its US counterpart by 8 percentage points this year. Instead of becoming the top performer as Wall Street predicted, Chinese stocks languished as one of the worst laggards. And strategists at firms from Morgan Stanley and Goldman Sachs are rushing to lower their forecasts.
At issue is China’s bumpy emergence from the pandemic. After an initial rebound following the end of the Covid restrictions, recent data has shown manufacturing is contracting again, the housing market is struggling, and local governments’ financing vehicles are scrambling to pay off their debt.
“Earlier this year, people were optimistic about the recovery of China post-reopening,” said Willer Chen, a research analyst at Forsyth Barr Asia. “But the reality is that we are facing a scarring effect.”
The currency market is another area where investors miscalculated. Back in December, the proportion of fund managers eyeing a lower dollar in BofA’s survey rose to the highest level since 2006. Underpinning the cautious view was the idea that a peak in US interest rates would curb demand for the greenback. Yet the dollar has stayed buoyant as a resilient economy and persistent inflation keeps it as one of the highest-yielding currencies in the developed world.
That was particularly frustrating for yen bulls who had envisioned that a potential shift in the Bank of Japan’s uber-easy monetary policy would reverse a two-year plunge. Despite firm inflation, BOJ’s new Governor Kazuo Ueda has repeatedly emphasized the risk of a premature reduction in stimulus.
The divergence in monetary policies caught many off-guard. At the end of January, when the yen traded at 130 per dollar, analysts surveyed by Bloomberg expected the Japanese currency to rally about 2% to 127 by the end of June. Instead, the yen has fallen to 140.
Bipan Rai, head of FX strategy at the Canadian Imperial Bank of Commerce, acknowledged that he was among those whose weak-dollar call was premature. But he holds onto his conviction that the US currency has room to fall with the Fed’s tightening cycle approaching an end.
“I’m still a believer in the bearish dollar story over the medium to long term,” said Rai. “We just need to be more patient.”
Still, it’s early days yet — and the aftershocks from one of the most aggressive Fed tightening campaigns in decades will be felt across the consumption and investment cycle for months to come. All that has the potential to reinvigorate strategies that were hyped up heading into 2023.
“The reality of it — we’re still in tighter financial conditions,” said Kristen Bitterly, head of North America investments at Citi Global Wealth Management. “Ultimately if we stay on this path or continue along this path, it doesn’t mean it’s impossible to be profitable, it doesn’t mean that consumers won’t continue spending. It just makes it more challenging both from the consumer standpoint as well as the corporate standpoint.”
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