Fundamental analysis is dead, thanks to the Fed

During the Great Financial Crisis of 2008, family offices were skating on thin ice.  In the great pandemic of 2020 they were dancing on the edge of a volcano.

Anyone capable of such feats is surely capable of anything. And today’s market data is certainly encouraging. The big question is whether we can even stand upright without support from the Federal Reserve, as it hints at interest rate rises by 2023 to deal with inflation.

Despite a sharp fall in bonds earlier this year, equities have recovered their poise, with Wall Street standing near an all-time high. The NYSE Fang-plus index of global internet stocks has bounced back from its May low of 6200 to hit 6750.

Jim Reid, veteran strategist at Deutsche Bank, has reluctantly come to the conclusion that the Fed changed the fabric of the market

The Vix index which measures the volatility of S&P 500 options subsided to 17.6, its lowest since markets were rocked by the pandemic 15 months ago.  The measure, known as the “fear index”, is below its long-term average of 20, suggesting enduring faith in US economic recovery.

The Move index which uses the bond market to indicate inflationary trends, is also restrained. Apart from its own bond purchases, the Fed can also rely on pension scheme purchases. 

S&P Global Market Intelligence recently produced an analysis that showed that US leveraged loan issuance rocketed to $170 million in the first quarter.  Around $67.4 billion, or 40% of the total, was issued by borrowers with a low credit rating less than B. Not much misery there, either. We haven’t seen anything like it since credit boom of 2007.

Low rates and a decent supply of loans is also boosting the housing markets. Consumer sentiment has also been helped by post-pandemic recovery, along with stimulus cheques and high levels of cash in household savings accounts.

Family Capital can find no sign of the venture capital market drying up, as disruption spreads across a range of sectors. The price of bitcoin has stabilised nicely at $39,000 after a sharp drop from its April peak of $63,000.  SPAC activity has picked up in the wake of a regulatory attack.

Data from Bloomberg confirms that bankruptcies have been as low over the last year as they have been in the last two decades. Zombie companies, kept alive by rock-bottom interest rates, continue in business. 

All this has a profound impact on investors who remain happy to bet on growth funds and procyclical indexed strategies, despite the recent value bounce.

In a recent strategy note, Karl Rogers of Athlon Family Office analysed the poor performance of equity long/short managers against the index over ten years.

He found that the top-performing quintile succeeded because their bets were relatively aligned with the market. The bottom quintile displayed greater skill in picking stocks only to be killed by a lack of correlation with the market.

All this is pretty distressing for any self-respecting hedge fund manager, accustomed to beating the market in previous years. Short bias hedge funds who bet on overvalued companies based on proprietary research have suffered even more, as have value investors who tend to pay attention to balance sheet strength than earnings growth.

So why bother with fundamental analysis, at all? Following the Fed’s intervention, the market has already become less analytical. A wall of money is chasing dud companies and unlikely venture capital plays, without worrying much about their financial strength.

Jim Reid, veteran strategist at Deutsche Bank, has reluctantly come to the conclusion that the Fed has changed the fabric of the market. Its stance on monetary stimulus has trumped fundamentals, as newly-minted cash rushes from one opportunity to another.

None of this matters, for now. But now the Fed is talking about two interest rate hikes in 2023, plus a gentle tapering of its bond purchases over time, as post-pandemic inflation continues to climb. 

We’ll be lucky if we free ourselves from central bank monetary stimulus that easily. Some would say we never shall.