Hedge fund managers spend most of their time convincing their clientele the "alpha" their fund generates truly distinguishes itself from the herd to justify that 2/20 or 1/10 fee structure. It is true that hedge funds used to present de-correlated returns to the market and outperformed both on the way up and down.
Over the years, however, the percentage of "alpha generation" has come in and most funds tend to mimic market returns, and some are just a pure levered bet even. This is all thanks to the U.S. central bank, which has printed free money to no end over the past decade, especially since the Global Financial Crisis.
Since 2008, the system is so stretched because the Fed has printed its way out of each economic wobble. Every two years or so we get some hiccup in markets, be it repo markets, dollar offshore swap markets or trade wars, and it causes the Fed to do the one thing they know how to do, just keep printing. Today, the balance sheet stands close to $8 trillion, and they are still adding $120 billion/month in Treasury assets, a year after the pandemic struck and despite the reopening and markets having recovered.
This excess liquidity is one of the main reasons why all assets have more or less moved together in the same line, up. Some, given their extreme leverage (cryptocurrencies) are just multiple digits exposure to more or less the same thing, leading us to the "Everything Bubble." Of course, some of these assets do tend to have "decent" fundamentals and strong demand/supply balances like copper and iron ore, to suggest an upwards trend but the extent gets exacerbated due to the enormous liquidity in the system that has forced investors to invest in anything that gives them a yield, as cash is getting debased every single day.
On the back of this latest QE expansion, the market once again is debating between inflation and deflation. At every top end of the range the same question is on investors' minds: "Will this time be any different?"
If one were to look at the S&P 500, Nasdaq, Russell 2000, or even copper, or Bitcoin, they all present the same broader trend, and that is one of a liquidity surge. Of course, Bitcoin and its crypto brethren have outperformed by 10x, but taking a step back and simplifying it, they all point to the same thing: too much money chasing too few assets.
The Fed has constantly claimed the latest inflation spike as "transitory." They have no choice but to keep saying that, as, honestly, they do not have a clue. They hope that this time will be like the previous 10 years where the Modern Monetary Theory experiment saved the day each time. Only this time around we are seeing CPI inflation spiking towards 4%+ and month over month showing high-single-digit figures not seen in the longest time. If we adjust the CPI Fed measure, which tends to underestimate inflation any way, real inflation seems closer towards 8%-10%!
If one were to look at prices of soya beans, coffee, lumber, used cars, steel, copper -- the prices of all goods and services across the board have skyrocketed. This is not only because of the massive infrastructure and stimulus boom central banks embarked upon, but also due to the massive shipping and supply chain bottlenecks that are causing this severe tightness. The system is not made to handle such shocks and companies are now passing the higher costs onto their customers. This at a time when 16 million Americans are still jobless and not incentivized to look for one given the stimmy checks handed out by Uncle Sam.
The Fed has to decide what to do, chase employment or reign in inflation before we get to a hyper stagflationary environment which can only mean a much worse environment for both equities and bonds. They seem to be in a Catch-22 situation.
If they do decide to tame inflation and withdraw liquidity from the market, make no mistake, every asset class will see derisking as all the speculative money comes out. Some will manage to fall a lot less in relative terms given how tight some physical markets are, but the direction will be the same.
It is easy to be impressed by some funds' performance, but let's face it, this has all been one big macro trade!
