Goldilocks vs. Cassandra in the markets

By Andrew Beer, managing member of Dynamic Beta investments

Two camps are battling it out in the markets. One – the Goldilocks contingent – believes inflation has peaked and will drift lower, the economy will slow without a major recession, and the Fed will start cutting rates again by year end. For them, 2022 was an unpleasant pause before a return to the Go-Go 2010s. The other – call them Cassandras, and many of them battle hardened macro traders – think inflation will remain stubbornly high, the Fed’s job is far from done, higher rates will reverberate through a leveraged market ecosystem, other macroeconomic and geopolitical issues will rear their ugly heads at inopportune times, and a deep recession might be necessary to put the inflation beast back in the bottle.

For eighteen months, the Cassandras were right; for the past three or four, and especially in January, the tide has shifted in favor of the Goldilocks crew. One irony is role reversal: many Cassandras fought the Fed for years, while today the Goldilocks are calling its bluff. Another is that the more the Cassandras win in the near term, the more likely the Fed will have to further dial up rates and rhetoric – essentially what happened after the last gasp of the Transitory trade in July of last year.

Our macro view leans toward the Cassandra camp – not to the more farfetched predictions of social and political disintegration, but that the reversal of a decade of unprecedented fiscal and monetary profligacy will be a struggle over years, not quarters. But we also recognize that macro calls have a very high error rate – and in fact, many of the worst fears last Fall – gas rationing in Germany, economic paralysis in China, an expanded land war in Europe, etc. – failed to materialize. And even when the calls are right, the markets can respond in unexpected ways: e.g., the panicked “dash for trash” last month likely surprised most in the Goldilocks camp. This broad caution drove our decision to focus on the positioning of seventy hedge funds, not one or two, diversified across strategies and sub-strategies, strategic and tactical. We hope their collective judgment will enable us to continue to chart a steady path through these rough seas.