(Bloomberg)-How much longer will the Federal Reserve let stocks slide? That’s the flaming question of the moment for the financial markets, and Greg Jensen, co-chief investment officer at Bridgewater Associates, has the answer: up to 20% more.
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This would put the S&P 500 below 3,500, or close to where it was before the Covid-19 pandemic began two years ago. The benchmark US index closed Wednesday at 4,350.
The reality, Jensen explained, is that policymakers have little reason to stop the selloff that saved most speculative stocks and pushed equity volatility to a 12-month high. Conversely, inflation in the US is running at its hottest in four decades, labor is low and companies are building inventories because of supply-chain threats.
“Some drop in asset prices is not a bad thing from the Fed’s perspective, so they’ll let it happen,” Jensen, 47, said in an interview with Zoom. “At these levels, it will take a bigger step to put the‘ Fed ’in the money. They are far from there. ”
He thinks it will take a 15% to 20% drop to alarm the central bank, and even that depends on how quickly the bottom falls from the bottom of the market. So far, Jensen said, the decline over the past few weeks has been “mostly healthy” because it has “deflated some of the bubbles,” such as cryptocurrencies.
House View
Jensen, who serves as co-CIO with Bridgewater founders Ray Dalio and Bob Prince, represents the house view of the world’s largest hedge fund, with approximately $ 150 billion in assets. And in Bridgewater’s analysis, most of what’s happening recently is simple math: Asset prices have risen through injections of “excess liquidity.” Now that policymakers have withdrawn that monetary stimulus, “there aren’t enough consumers to make a difference,” Jensen said.
The result is what he calls a “liquidity hole” that affects both stocks and bonds.
Anyone expecting the Fed to blink, as it did after the last pre-pandemic selloff in late 2018, is misreading the economy, Jensen said. Things were different then. Inflation is less than the Fed’s 2% target and large companies are buying shares instead of adding capacity, storing supplies and raising wages.
Fed Chairman Jay Powell inherited an orthodoxy built on Alan Greenspan. In Jensen’s words:
“Since the 1980s, problems have always been solved through mitigation. That’s true financially and monetaryly, and countries that have weakened have done better than countries that have weakened less,” he said. “We’re at that point now and things are going to be different.”
For the first time since Paul Volcker’s Fed in the early 1980s, inflation has accelerated so fast that it has become a political issue. Powell, speaking to reporters after the Fed meeting on Wednesday, acknowledged that the central bank may need to raise borrowing costs faster than the market expects to prevent prices from rising. of increase.
Jensen doesn’t think the Fed wants the market to collapse, just reset to a level where it largely reflects money flows in the “real economy” and is no longer a channel for generating inflationary pressure. He expects policymakers will watch closely to see if lower asset prices have any impact on job creation.
One question Jensen raised was who would buy all the bonds the Fed has soaked in quantitative easing. In addition to raising rates in March, policymakers are set to end the asset purchase program that has boosted the central bank’s balance by a trillion dollars.
Jensen said he thinks the Treasury’s 10-year yield needs to reach 3.5% or even 4%-from less than 1.9% today-before private investors are ready to get all the debt. of the Fed -funded government.
In that scenario, with Treasury prices set to fall further, bonds fail as a hedge against stocks and the traditional 60/40 balanced portfolio is useless as a diversification tool. Jensen said a 1970s-style “stagflation” playbook would be more appropriate, and investors would need to increase their commodity holdings, trade out U.S. stocks in favor of international equities and use breakevens to fight inflation.
“Expecting the environment to feel like this over the past few decades is a big mistake,” he said.
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