Living in the New ‘New Normal’

After a hugely successful year running large (negative) momentum strategies on a wide range of assets, Macro traders have been more cautious in their ‘bets’ so far this year and many are in fact putting on mean reversion strategies in January, i.e the opposite of last year’s winning trades. They are doing this for two reasons; first, they acknowledge that the distressed selling they triggered last year is now over and having taken profits themselves last year, there is no much profit in ‘going again’ and second, they are also acknowledging that the medium term asset allocators are doing some mean reversion of their own, buying back the underweights in non US assets and reducing overweights in the $. It is against this background that we approached the annual talking shop of the World Economic Forum (WEF) in Davos last week.

When Adam Smith noted that “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices” he might easily have been predicting the modern Western Political Economy as demonstrated by Davos. Here, an unlikely alliance of European Social Democrat dirigiste politicians and their permanent bureaucrats convene annually with a cast of multi-national multi-millionaires and billionaire ‘businessmen’ under the auspices of ‘improving the world’ for the rest of us. The reality meanwhile is of course, as Adam Smith said, to work out how to make the world better for themselves at our expense.

There are of course many such private groups, but Davos rose to prominence in the wake of the 2008 financial crisis as Central Bankers in particular and politicians in general ‘took back control’ and investors have learned to look to Davos for clues as to how policy is going to be shaped. Most obviously, since 2008, Davos has evolved to represent the more authoritarian aspects of globalism, with the three dominant strategies of the last decade or more; Zero Interest Rates, Zero Carbon and Zero Covid all heavily supported and promoted at Davos and being imposed centrally, without seemingly troubling anything so bothersome as a party manifesto or democratic mandate. But times are changing and, with the first and last of those strategies now thankfully firmly behind us, this year’s meeting was left to concentrate on the remaining strategy of Zero carbon, whose investment manifestation of ESG had a nasty conflict with reality in 2022, with its long tech/short energy profile proving a huge hit to capital values and losing a lot of interest, especially among Asian investors. A week earlier, Fed Chairman Jerome Powell had made it clear that the Fed was not getting involved in climate policy and it was also somewhat awkward that while Al Gore and John Kerry were there pushing the one issue all attendees seem to agree on, the patron Saint Greta was outside, lambasting the companies attending for ‘making money’. Meanwhile, the WEFs broader agenda of ‘new systems’ for just about everything was not greeted with much enthusiasm by those representing the systems the WEF wish to change.

This schism that is emerging between the idealists, the bureaucrats and the crony capitalists was perhaps a major reason why this year things seemed a little flat. There was only one G7 political leader (Germany), no Xi, Putin or Trump obviously, but no Gates, Soros or Zuckerberg either. In fact of the top ten richest people in the world, the only one that attended was Gautam Adani, who rather awkwardly saw his Adani group hit by a short seller with a massively detailed claim of fraud a few days later. Also awkward.

For investors though, perhaps the most interesting thing might be the realisation that the WEF’s much promoted Top Down ‘New Normal’ of the fourth industrial revolution and the notion that ‘you will own nothing and be happy’ has been replaced by the more prosaic, bottom up New ‘New Normal’, where everything is back to, well, ‘Normal’. First and perhaps most important is that interest rates are basically back to ‘normal’, something approaching a natural rate of interest, ending the destructive mis-allocation of capital of the QE era and now allowing normal companies, on normal margins, selling normal goods and services to normal consumers to make normal profits. The flip side is the zombie companies being historically propped up by ultra cheap money will now go under, restoring competitiveness to normal companies and ending a lot of the dis-inflation that came with excess supply, giving an apparent inflationary boost and a narrowly focussed but painful credit cycle. Importantly though, the one area that is not ‘normal’ is the one seemingly embodied in a lot of macro commentary; this is not a normal credit cycle; we are not putting rates aggressively above the natural rate of interest. We are putting them back to, normal. As such, we suspect that the second leg of a bear market – the one where aggressive tightening produces a collapse in earnings – may be muted, if it comes at all.

Ultra-long duration ‘themes’ promoted by companies with no earnings, or earnings that are now less than interest payments are out, cash and cashflow are back in. After a year of getting stuck, or locked out, low liquidity is being seen as a source of risk, as is a business model based around access to cheap capital. Less top down Davos, more bottom up business models. Welcome to the new, ‘New Normal’.