Bridgewater Associates, Inc.Co-CIO Karen Karniol-Tambour joins Positive Sum CEO Patrick O’Shaughnessy at the 2023 Sohn Investment Conference. Below is the interview she says the market is very asymmetric right now because of the asymmetry between the upside vs. the downside, and I agree.

I’ll summarize:

If the economy enters a recession, it’s very bad for stocks, and this time the Fed is unlikely to immediately respond by lowering rates since inflation is a problem. So, the downside risk is large. It’s already priced-in to the stock market, so it won’t be a big surprise. Not a lot of upside potential.

If the economy doesn’t enter a recession, the Fed will be in a tough decision point, because inflation is unlikely to come down without a recession. If the Fed doesn’t ease like it’s already price-in, the market is going to be disappointed.

It’s asymmetric because the downside potential is greater than the upside.

The interview:

Patrick O’Shaughnessy:

What do you think that prevailing valuations, let’s say, just on like the big asset classes tell us about what the market thinks is going on? Like, what does it seem like is in prices right now, if you will, as you look at S&P 500 you know, multiples or something very basic like that?

Bridgewater Co-CIO Karen Karniol-Tambour:

WellI think the stock market is telling you that there’s going to be a modest economic slowdown, a pretty contained economic slowdown, nothing like you know a significant recession or anything like that, With that slowdown alone, the Federal Reserve is going to find that sufficient to go ease from you know, 5% to 3% extremely quickly, and that its going to do that despite where inflation is today because inflation is going to go back to totally reasonable levels that they want very very quickly. You see that kind of across stock and bond pricing you know bond pricing is telling you in places to be fine we’re not there’s no inflation from anything like resembling long term and the Fed’s about to ease pretty significantly without a significant slowdown.

Where that sort of leaves you is if the market I believe is asymmetric it’s very asymmetric because it you actually get an economic slowdown; that’s obviously very bad for stocks. I don’t have to tell you that that would be you know pretty bad for stocks. But there’s really not much of a recession priced into them it would be pretty bad. Usually the way you get out of that (as I was saying) is that every time there’s a slowdown the Central Bank just comes and eases right away. Now, not only will it be much harder for them to ease because inflation’s been more a problem. Tension is there, but that easing is already priced in and so even if they do kind of bite the bullet and say “I’m not going to worry about inflation” and ease, it’s already in the market prices it’s not going to surprise the market so much.

Then, on the other hand, if the market doesn’t slow, if the economy doesn’t slow so much, if we don’t get that kind of recession if the equity prices are right that you’re not going to get a big recession and the fed’s going to be a tough spot because I don’t really see why inflation’s going to come down with no recession. You have a very very strong labor market if nothing slows and so if they don’t ease like it’s already price they’re going to be disappointing. So, every day once we hit summer the Federal Reserve doesn’t pivot and ease that’s effectively a tightening relative to what’s priced in that’s also disappointing.

That’s a lot of room for disappointment that can happen whether the economy is strong or weak.

Patrick O’Shaughnessy:

That’s all sort of like what I’ll call you know relatively near to intermediate term future how do you think about portfolio positioning in light of that general view when you know like you for a long time it’s paid to just be long risk and have a very simple portfolio because of everything you’ve discussed. How’s that different today like how would you how do you think about positioning against this asymmetric setup that you described

Karen Karniol-Tambour:

I think it’s one of the toughest times to be an investor in many years because you know as you’re saying risk assets has been so good and I think risk assets are about as unattractive as we’ve seen a very long time and they’ve and that’s we’re seeing that come to fruition they don’t just bounce back you don’t just get kind of automatic rallies no matter what so it’s a hard time to be an investor I think as an investor you have to think about diversification in a different way diversification just wasn’t that important because the one asset people hold “equities” was just the strongest outperformer and the different places investors can kind of look they can look at geographically so they can look at geographies that have less of this tension places like Japan or China where you’re in a different situation you’re not about to hit a big Central Bank tension Japanese Central Bankers are pretty excited about getting higher inflation they’ve won for a long time and it’s far from, you know, out of control.

She basically suggests U.S. stocks are overrated and Japan stocks, Emerging Markets stocks, and Gold, are underrated.