As excerpted from from the weekly markets/macro comment by Tony Pasquariello, Global Head of Hedge Fund Coverage at Goldman Sachs
I went back and read a batch of emails that I sent over the course of this year. it’s a humbling exercise, but I think valuable -- it illustrates the broad direction of things, as well as how much noise, clutter and emotion we absorb along the way. in the doing, you also realize what gets traction (references to coffee, baseball trivia and my grandparents 1) and what doesn’t land quite as well (you’re tired of New England sports references, I know). In the end, we should give thanks, as 2021 will go down as one of those extraordinary years, certainly in the US: record M&A ... record new issue ... record retail activity ... all-time highs in the equity market, the housing market and the digital space ... long may it run.
some parting thoughts on 2021:
1. the year began with a marriage of fiscal and monetary policies the likes of which the world had never seen; the year ends with a potentially failed BBB bill and a central bank that’s quickly getting out of the bond buying business. I’ll get into the implications of this shift in the 2022 section.
2. looking back, despite so much intoxication at the time, it’s notable how many things topped out in Q1 -- not only in the reflation foot race (the high close on 10-year note yields was 1.74% on March 31st), but also in highly valued tech names (see GSXUNPTC), the renewables space (GSXURNEW) and SPACs (GSCBSPC1). in a way, it’s remarkable that Q1 marked peak exuberance, yet the broader market continued to make higher highs for many months thereafter; again, this is largely to the credit of the US mega cap tech names, who yet again beat the pants off most every other item on the global menu.
3. what to say of COVID? it faded, at times, from the market narrative, but kept coming back in problematic ways. I’ll go back to a comment from July on Delta, which hopefully proves to be a cut-and-paste for Omicron: “to this point in the local move I'd argue the role of the variants has one been of concern around economic impingement -- relative to very high growth expectations -- rather than a game change; as we look ahead, the UK reopening experience could be the perfect stress test for whether stocks should discount something more than that.”
4. the year featured a painful disjunction between “the stock market” and “the market of stocks.” you don’t need me to say it, but I can’t recall a year where headline market returns so hugely belied the difficulty of managing professional, levered funds along the path. even before you consider that S&P has added nearly 1,000 index points this year on a Sharpe Ratio that approaches 2.0, here’s an overly simple way to frame it: if you take the YTD total return of the GS Hedge Fund VIP basket ... and you triple it ... you still fall short of S&P 500.
5. if there was ever a doubt about who wields power in the stock market, the US retail investor stole the show in 2021. following a year that saw more inflows than the prior 25 years combined, to what extent this cohort remains in the fight is a major open question for early 2022. in general, for financial actors of all stripes -- households, corporations, sovereigns, your alma mater -- I tend to think one of the big unknowns for next year is simply: where does all the capital go?
6. on many days, the options market overpowered the underlying cash equity market. whether it was short-dated upside gamma grabbed by retail investors on their favorite single stocks, or record demand for index protection by professional investors, at various turns we saw the clear footprints of plain old calls and puts on the broader market. to recall a line from the great Emanuel Derman: “the central dogma of derivatives is that causality flows from underliers to derivatives, but that hasn’t been true for a long time.”
7. in January of this year, headline CPI registered +1.4% y/y ... the last print was +6.8% ... and, it’s not crazy to think that number will be upwards of 7% come January. if you had told me at the start of the year how the inflation narrative would pan out, I certainly wouldn’t have predicted 10-year note yields of just 1.48% ... nor that gold would be -- gasp -- down 6% ... and, if I’m being honest, I don’t think I would have predicted that S&P would make a high over 4700. I’ll again reference a quote from Morgan Housel: “we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance). physics isn’t controversial. it’s guided by laws. finance is different. it’s guided by people’s behaviors.”
Thinking ahead to 2022:
1. the big ball: the setup for risk taking is changing. I can no longer stand up and say that the outlook for growth is totally spectacular ... nor can I say that both fiscal and monetary policy is utterly unbounded. so, the inconvenient truth is we’ve passed the near-perfect points of peak activity and peak liquidity. and, when you go from that remarkable brew to something, well, “less great” or “different,” I think it has to matter to asset markets -- particularly when the base line is the COVID era produced a Sharpe ratio on 60/40 portfolios which is 3x the long-term average. at the very least, it’s harder to see the upside tail as clearly from here, therefore the era of “irresponsible bullishness” is probably over for now.
2. following an era where the total return of S&P has been positive in 12 of the past 13 years, does that mean it’s game over for the bull market? with appreciation for the prior point and a lowering of expectations, I’m not inclined to ditch Old Turkey just yet and I think there are still good macro fundamentals to anchor to. from here, the bull case is now predicated on the 1st derivative:
- financial conditions are still ridiculously, if inappropriately, easy -- note that US 10yr real rates are 15bps lower today than they were before the PFE news last year;
- the underlying economy retains significant strength into next year, and a +3.5% GDP forecast is still well above-trend;
- if S&P earnings growth 8% next year, the index has significant underlying ballast.