If a disappointing jobs report combined with an unwinding of the yen ‘carry trade’ was enough to trigger an indiscriminate sell-off earlier this month, there may not be enough risk priced into markets.
This is what concerns Muzinich & Co founder & executive chairman George Muzinich, who warned in a recent note that the recent sell-off could be “a precursor” to more volatility.
He said: “Even if later in the week the market recovered nicely, we must keep in mind that we are living in a momentum driven market and not one based on compelling valuations.”
“We need to ask ourselves, was that one day of market contraction an aberration in a still smoothly sailing market? Or was it a precursor of more such tremors? We are concerned it may be the latter.”
Indeed, it seems that even US Federal Reserve chairman Jerome Powell, who was previously focused solely on fighting inflation, has now grown more concerned about other risks looming for the economy.
At the Jackson Hole conference in late August, he said “the balance of the risks to our two mandates has changed”, acknowledging that the likelihood of recession has now grown relative to the risk of inflation.
Too much debt
Muzinich, whose investment firm manages $35bn in credit assets, fears that it will be “difficult to deleverage the economy without creating recessionary pain”.
“Our concern is that charting the course just right will be difficult,” he said. “We need to come to the realization that there is simply too much debt out there.”
“Our government debt is increasing in alarming proportions,” he added. “The real estate market in many parts of the country is buckling under the stress of too much leverage.”
“We gorged on debt during the period of very low interest rates, and we must now live through a period of catharsis.”
Given how much borrowing took must have taken place to cause the Yen ‘carry trade’ to disrupt global financial markets, there is a concern that the unwinding of another leveraged part of the market could pose more hidden risks.
Muzinich pointed to the resignation of JPMorgan’s Marko Kolanovic, one of wall street’s biggest bearish strategists as a sign markets could be growing complacent to potential risk.
“We do not try to predict short-term market gyrations, but there is enormous danger when there is an overall consensus that there is little risk in the market,” Muzinich said.
Too much riding on AI and a soft landing
The investment veteran also criticised investor optimism for artificial intelligence (AI) and suggested that excitement for a few tech stocks may be distorting investor expectations.
He said: “Our thinking about valuations has become distorted in the last few years by disruptive technologies of seemingly infinite potential.”
Indeed, investors are betting that the huge sums of money being invested into artificial intelligence and related technological will someday provide extraordinary returns on capital.
“We have become suddenly aware of new continents of opportunity and untold riches,” Muzinich said.
“But we should also not lose sight of the uncertainties and perils that abound in these visions of new lands of milk and honey.”
He also is sceptical as to the inevitability of a soft landing where inflation is tamed without causing a recession, sometimes dubbed the ‘goldilocks’ scenario.
“We have also been fond of comforting ourselves in the optimism of a soft landing, of successfully navigating a course between Scylla and Charybdis,” he said.
“We liked to think that if markets went up when interest rates were rising, they should surely continue to go up once interest rates are likely to start declining. And so on and so on.”
“We, however, have preferred to ignore the fact that we are living in a kind of La La Land. Where we can keep printing money at will and, at the same time, keep doling out money without serious reason or restraint.”
