(Bloomberg) — Despite a brutal start to the year for their portfolios fueled by a surprise market rally, two top-ranked fund managers are sticking to the bearish views that made them winners in the stock crash of 2022.
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Jeff Muhlenkamp, whose Muhlenkamp Fund delivered positive returns last year, says raised interest rates will continue to wreak havoc in the market, though it is likely the Federal Reserve will make a soft landing. In addition, there is a risk that aggressive policy tightening ends up in a recession, with the worst-case scenario sending the S&P 500 down as much as 30% by Thursday’s close. His fund currently holds more than a third of its money in cash.
Muhlenkamp’s skeptical colleague James Abbate also sees the equity rally as nothing more than a bear market trap. His Center American Select Equity Fund, which outperformed 96% of peers in 2022 according to data compiled by Bloomberg, has in recent weeks set up new hedges through put options. The four-month gain has pushed the S&P 500’s price-earnings ratio above its 10-year average, at a time when corporate America’s profit machine is fizzling out.
“I have a hard time seeing how the market can go up materially in this environment,” said Abate, 57. In fact a recession takes hold.
His skepticism echoes a large swath of Wall Street professionals who resist embracing an advance that has lifted US benchmarks as much as 17% from October lows. While bears have been forced to open short positions, there are signs that some are ready to chase profits.
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In fact, Goldman Sachs Group Inc. Hedge funds tracked by major U.S. brokerages reduced their long holdings last week as stocks soared. Caution seems to be forecasting, with the S&P 500 falling this week as Treasury traders bet on how high interest rates will play out.
For fund managers who took over the world and won last year thanks to defensive positions, the decision to hold is not without pain, especially at a time when virtually all 2022 trends have reversed.
The Ebates Center Fund, which has topped 99% of its peers over the past three years, has lost some of its luster, as energy stocks — its largest industry holdings — were supplanted by technology as market leaders. . Up nearly 6% this year as of Wednesday, it lags the S&P 500 by 1.6 percentage points, ranking near the bottom quartile among comparable funds.
The reversal prompted Muhlenkamp to do some soul searching. The lack of cheap-looking stocks and the poor outlook have prompted his fund to park a substantial portion of the money in cash, a strategy that helped deliver profits during the bear market of 2022. With 35% cash now, the cautious position is working against him. The fund, which his father Ron Muhlenkamp started in 1988 with an intense focus on value, is already lagging the market by about 5 percentage points a week into the new year.
“There’s a huge gap between what the market is doing and what I should be doing,” Muhlenkamp, 56, said. “If indeed we are entering a renewables market rally, the longer I sit in cash, the worse my performance will be. The flip side of this is that if I put all that cash to work I think based on what the market is going to do, not what is going on in individual stocks, then I run the risk of being completely wrong.
Last year, his top three concerns were: the worsening energy crisis in Europe, potential turmoil in international markets from a strengthening dollar, and Fed tightening. So far, two of them have seen a correction – a warm winter in Europe has dampened demand for oil and natural gas, while the dollar is down nearly 10% from its 2022 peak. Yet the threat from the Fed remains.
“It is most likely that the market is still going to go down from here,” Muhlenkamp said. “If it comes out, you’re going to be looking for some really stupid prices, because when things start going down again, people are going to be heavily leveraged. It generates a selling machine that Creates ridiculous prices.
That kind of rush to exit was largely absent during the 2022 drawdown. In fact, Cathy Wood’s ARK Innovation ETF attracted billions of money during its 67% plunge. In particular, there has been an unsettling revival in risk stocks so far this year, with more pronounced gains in unprofitable tech and retail darlings.
For Muhlenkamp, who is based in Wexford, Pennsylvania, the dip-buying mentality is still alive and the market has yet to budge, reaching an inflection point that usually sets the stage for a sustainable rally.
At centre, Abate also kept a close eye on what he could miss. Lower bond yields and better-than-feared earnings were reflected in the latest bout of the market boom, in a New York-based investor’s view. For that, companies have refrained from spending big money on capital investment during this cycle, which is different from previous crisis periods like 2000 and 2008.
It is not that the threat of recession is over. According to Abate, the dull ambiguous outlook is likely to keep the market in a wide trading range, as it has been since last June. During that period, the S&P 500 was mostly stuck in an 800-point band, causing headaches for bulls and bears alike.
“Unfortunately, we are going to live in an environment of maximum desperation,” Abate said. “People have to be prepared for this to last longer than 12 or 13 months.”
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