SIMON BROWN: I’m chatting with George Herman, chief investment officer at Citadel. George, I appreciate the early morning. You put out a note and I have to say I read through it and there were a couple of times when my eyebrows were raised, because it was just something I hadn’t thought of or I didn’t know. In the first [point] you start off and you say up until the end of last year equities had done all right. We’d had the stimulus rally. It’s been a rough 2022 so far, but you made the point that if we zoom out 18 months and go back to the beginning of 2021, actually much of the market equities, commodities, etc, are positive over the period?
GEORGE HERMAN: Simon, the main point of the article was just to zoom out a little bit, because a lot of the narrative is very negative right now. Because markets have become very volatile the overall sentiment has just gone so negative. Whereas, firstly, it’s just the adjustment of several variables that needs to happen, but also that we must see it in the context of the global issue. So it’s really not all negative.
SIMON BROWN: Yes, absolutely. Investing is long term, and here we are sort of focusing on six months, which is many things. It is not long term.
Talking around declines and some data – and this was another [thing] which absolutely opened my eyes – you say during non-recessionary periods the medium decline is around 11%. During a recession it’s around 33%. We don’t know where we are with that recession, but we are kind of sitting in the middle at 22% down, which is, I suppose, the market being right. We don’t know if we’re in a recession and the market is pricing in just that, in a sense.
GEORGE HERMAN: That’s exactly the mood. [It’s such an] important point right now, because the world is uncertain as to whether we are going to go into a recession or not. Now, those data points are based on US data, but let’s say that that’s representative of the world, and so you can see that it sits right in the middle. Our current drawdown is essentially saying, ‘OK, we’re not a hundred percent certain whether we’re going into recession or not’, but right now that’s not the important part. Firstly, you saw there that the stats suggest that a drawdown on average in recessionary periods is 33%, but we know of course that sometimes it could be even worse than that.
But the fact of the matter is the market is now no longer focusing on recession (the US might already be in recession). What it’s now focused on is the fact that earnings will most probably start cooling down because forward earnings have not been adjusted lower at all, whereas growth expectations have dramatically been revised lower all around the world.
So the equity market has essentially expunged all of its excitement and it’s sitting in the middle and just waiting for earnings to arrive.
SIMON BROWN: Yes. You made the point that inflation and interest rates are kind of under control and we have moved on, and it’s earning season. That’s what the market does. It’s looking forward and it’s saying, ‘okay, inflation, we didn’t see that a year ago, but here it is. And we didn’t see [interest rates rising] as fast, but here it is.’ And kind of that’s what markets do. They adapt and then look up to the future again.
GEORGE HERMAN: One hundred percent correct, because the US inflation number [will be] published tomorrow. That number – consensus is anywhere between 8.6% and 9.2% for tomorrow’s print. So that’s backward looking, and that is probably the worst point that we can see in US inflation, whereas forward looking we have seen that commodity prices have already declined dramatically. Many of them are down as much as 30% from their highs.
So undoubtedly the pressure on inflation going forward has already moved on, and that’s exactly why the markets have moved on in this narrative towards earnings. The problem now is that food supplies and a living crisis are kind of something that people feel very close to the bone, and it really becomes personal.
When that happens anxiety increases, and if you experience that anxiety while financial markets are this volatile, then it’s easy for an investor to feel generally negative about the markets.
SIMON BROWN: I take that point and it shouldn’t be [so], but we do take it personally.
A last point. You end off by pointing out that your philosophy at Citadel is that the future is uncertain and will surprise. I agree. Because of that uncertainty we almost need to be prepared for surprises – and they might be good or bad. But the future is going to surprise us almost either way, because we have so little certainty.
GEORGE HERMAN: Yes, exactly. The markets always teach you to stay humble and, secondly, to do scenario planning [so] that you are prepared for what you don’t consider is possible today [when it] becomes very much the norm tomorrow. So you have to be prepared for all eventualities and your investment portfolio should be structured as robustly as it can.
SIMON BROWN: Robust – that’s the word we’re looking for. We’ll leave it there.
George Herman is chief investment officer at Citadel, I appreciate the early morning insights.
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