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Yikes.
There’s bearish, there’s really bearish, and then there’s Ruffer & Co.
I don’t want to spook everyone managing their own retirement portfolio. But the London-based money managers, who successfully anticipated the dot-com collapse and the global financial crisis, are expecting an almighty stock-market crash — and are now holding nearly 60% of their flagship Total Return fund in cash and short-term bonds.
Plus another 20% or so in longer-term inflation-linked bonds and gold. And holdings in safe-haven Japanese yen. And put options on the market, which will pay out if things fall apart.
Total stock-market exposure? Er … 15%.
The fund is now hiding even deeper in its bunker than it was in 2007, before the global financial crisis, co-manager Steve Russell says.
Its exposure in “2007 was similar in terms of low equity exposure,” he tells me. “It was more like 20% to 25% then, compared with 15% now.” (I interviewed Russell for a Barron’s Live podcast late last year.)
Russell laid out the case in more detail in a recent note to clients.
“Markets still believe in a ‘soft landing’ — inflation dissipates without a recession. Yet we stick to our increasingly unfashionable belief that record monetary tightening’s full impact has yet to be felt,” he and his co-managers wrote. “Locked-in low rates and faster nominal GDP growth have likely deferred — but not defanged — the biting point.”
And cracks are starting to show in the U.S. economy, as well as economies elsewhere, they wrote. “COVID-era excess savings have been spent; consumer confidence is slowing; Q2 GDP growth and recent payrolls were revised lower; U.S. department stores are reporting rising credit-card delinquencies.”
Notably, this was written weeks ago — before the latest market rout. What is likely to happen next?
“Central banks could soon find themselves in a much trickier situation as inflation ‘base effects’ and (now rising) energy prices switch from being disinflationary tailwinds to inflationary ones,” he and his co-managers wrote. “If economies continue to slow, this could raise recession risk by forcing central banks to stay inappropriately tight. But if economies reaccelerate — especially in the U.S. — it raises the specter of a second inflationary wave, with further rate hikes.”
You could say the bond markets are now catching up with Ruffer’s thinking. Certainly the dramatic surge in Treasury yields in recent weeks would suggest the markets are now starting to expect not just “higher for longer,” but much higher for much longer.
Otherwise, how could rising expectations that the Federal Reserve might delay its interest-rate cuts for a few more quarters result in a dramatic rise even in 30-year interest rates?
Since the start of August, the yield on the benchmark 10-Year Treasury note has risen by a fifth, from 3.96% to 4.74%. That is a staggering move in such a period. The S&P 500
SPX,
so far, has dropped just 8% over the same period. The more volatile index of smaller company stocks, the Russell 2000
RUT,
has fallen 14%.
The bearish stance in Ruffer Total Return reflects the outlook of the firm’s eponymous founding chairman, Jonathan Ruffer. In a new letter, he predicts a major reckoning ahead, where persistent inflation, massive government debts and higher bond yields finally wreak havoc on stock-market valuations.
Ruffer so far has done poorly this year, as the chairman admits. He argues the firm’s bearish bets are early, not wrong. “We think the liquidation event has only been postponed, not canceled,” he wrote a few months ago.
Ruffer’s main claim to fame is to have successfully sidestepped the 2000-2003 and 2007-2009 market collapses, and the chairman recalls that he was early on both of those occasions as well: His funds underperformed in 1998-1999, and in 2006-2007, before the wheel turned.
“Our settled aspiration is avoiding the market crevasses, and in this we have been successful in every case going back to 1987,” he wrote in July. “My experience suggests there is almost an inevitability of underperformance in the run-up to a market setback.” He recalled ruefully missing out on the dot-com mania in 1999, and watching his big holdings in Swiss francs and Japanese yen sink in 2006-2007, during the final months of the bull market.
It’s been similar this time around: The Japanese yen, typically a safe-haven currency, has been plunging all year, as hedge funds and others borrow at low interest rates in yen and lend at higher interest rates in dollars and other currencies.
“That currency mismatch is making money for them (in addition to the small interest charge they pay) — their contentment has turned to happiness,” Ruffer wrote. “You don’t have to be a genius to see that, in a crisis, everyone will de-risk; that will include neutralizing currency mismatches, and end the happiness. In a crisis, we expect to see a strong upward move in the yen.” In 2008, he added, it rose by a third against the dollar.
Ruffer expects a “liquidity event” — a “dash for cash.” This is exactly what happened during the fall of 2008, after Lehman Brothers imploded and Congress, responding to the peanut gallery, initially voted down a bill to shore up the financial system. It also happened during the COVID crash in March 2020.
In moments like that, the only investment that really holds up is cash — typically meaning things like Treasury bills, because that’s what everyone needs. Blue-chip stocks, long-term Treasury bonds and gold all sell off initially, because everyone is hawking them to get their hands on cash they can use to pay bills.
Will this happen again? No one really knows. John Wesley, the founder of Methodism, used to complain that the devil had the best tunes. In the stock market, the bears always seem to have the best arguments. Nonetheless, stocks have trended higher over time.
Sitting mostly in cash, waiting for a 1929 collapse, is a risky strategy best left to those like Ruffer & Co. Financial consultant Andrew Smithers — like Ruffer, an Englishman — once conducted a long-term analysis on behalf of the endowment at his Cambridge University college. He concluded that a long-term investor should never be less than 60% invested in stocks. The costs of sitting on the sidelines waiting for a 1929, or a 1987, or 2008 implosion outweighed the occasional gains you’d make when they happened. (He also, presciently, argued that Treasury bills, not longer-term bonds, were a better counterweight in the remainder of the portfolio.)
This time around, the turmoil in bonds and stocks is spooking many ordinary investors. They don’t need to liquidate their portfolio, but they should make sure they can handle more volatility ahead. This isn’t a case for being 60% in cash, but it is a case for not being 100% in stocks. If the stock market suddenly hits an air pocket, especially a deep one, it’s good to be able to buy more stocks.
