The EPFR Exchange Podcast

Episode 101: Risks of Recession, Financial Sector, and Bear Funds

September 01, 2022 Kirsten Longbottom & Cameron Brandt
The EPFR Exchange Podcast
Episode 101: Risks of Recession, Financial Sector, and Bear Funds
Show Notes Transcript

In this week's episode, Cam and Kirsten discuss the likelihood of a 75 basis point hike in the US, the idea of recession risks being higher than markets are predicting, building exposure on what investors hope is the next leg of a long-running bull market and resilience in the sector space. We also take a look at what's going on in the areas of highest conviction through EPFR-tracked Bear and Leveraged Funds and discuss the dynamic between Thailand, China and Japan.

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Kirsten Longbottom 00:21
Hello everyone and welcome to the EPFR Exchange Podcast, my name is Kirsten Longbottom and we're joined here today by EPFR's resident economist Cameron Brandt. We'll walk you through what our teams were monitoring last week in the data that EPFR tracks as well as what we'll look for in the upcoming weeks. Cam, good morning. What do we have going on this weekend, anything?

Cameron Brandt 00:45
Are you talking about the global economy or me, I'm going to head up to the lakes region of New Hampshire.

Kirsten Longbottom 00:58
Another fishing trip?

Cameron Brandt 01:00
Catch up with family and friends though I will probably try and slip away this isn't first and foremost a fishing trip and you?

Kirsten Longbottom
Of course, not too much this weekend. We did get some paddle boards, so gonna go out paddle boarding for sure. That's our plan.

Cameron Brandt 01:23
Okay, so no drought constraints in your neck of the woods?

Kirsten Longbottom 01:28
Not yet, no. So for- On the economy side last week we talked about how the headwinds like the Russia-Ukraine conflict, drought weighing on transportation, agriculture, energy, covid cases and inflation remaining elevated... have all been leading to this broad thinking that those add up to slowed or halted economic growth. From my understanding, there have been some mixed opinions: some argue that there's no clear signs of a recession in the US to begin with, some highlight how the GDP fell less than expected in the second quarter which pushed the idea of a recession in the US completely away while the US- or maybe not completely. While the US Fed Reserve had some hawkish remarks ensuing some worry that we may jump another 75 basis points in the upcoming month. In our data this week we also saw Inflation Protected Bond Funds brought an end to a long outflow streak. What's your view on a recession in the US? Do you think it's likely, unlikely and how will the 75 basis point hike take to markets if it happens?

Cameron Brandt 02:46
Well, my impression from this past week is that the Fed would like us to think that sort of the risks of recession are higher than some people in the market are predicting. And obviously it doesn't suit their current goal of getting inflation under control as quickly as possible. If at the first sort of signs of things improving people say 'oh, it's all over whoopee' and start spending, you know they also now have to factor in the spending bill that the Biden administration got through the legislature. Again, there's debate on this but my sense is that that's certainly going to do nothing to bring inflation down and may well nudge it up. So in some senses, I think the Feds being the adult in the room, it's trying to point out that you know if people don't take inflation seriously and assume it'll be over at the first bite of higher interest rates, they could actually end up being with us at these levels longer than they expect. And certainly what our Fund Flows showed was that people took the hint and certainly kicked the tires on the assumption that in aggregate the recent headwinds we've been seeing - some of which have been with us for a while now - will add up to a much slower or even negative pace of economic growth which will bring down inflation and lead the Fed and other major central banks to ease back and even start cutting rates again ergo asset prices will be likely to rise.

Kirsten Longbottom 04:55
Where else did we see this taking effect in terms of EPFR tracked data, in terms of Fund Flows this past week?

Cameron Brandt 05:03
It was pretty broad-based and in much the same way people haven't kind of, I think, gone overboard in starting to build exposure to what they hope is the next leg of a long-running Bull Market. They didn't sort of go overboard in terms of bailing back out, I would say with the exception of High Yield Bond Funds and maybe Technology Sector Funds, we didn't see any group hit out of the park in terms of redemptions. By the same token, outside of Financial Sector Funds, there really wasn't much for any major group to sort of pop the champagne corks about.

Kirsten Longbottom 05:53
Right, well while we're on that subject. For sector funds this week we saw Financial Sector Funds pull in $2.5 billion and then Tech saw a $1.3 billion outflow both guided by funds dedicated to the US and institutional flows. Interest also picked up for Utilities, while Industrials and Consumer Goods fell into negative territory. How are earnings, monetary policy and consumer spending influencing flows in the sector space?

Cameron Brandt 06:28
Starting with financials which did see over $2 billion come in, certainly I think there's a sense that that sector was oversold. It's nothing if not resilient historically and is likely to find a path to profitability. Furthermore, even though the slower economic growth is obviously not inherently good for financial institutions, there's certainly ways around it and for the moment as many of our colleagues have noticed the recent Fed rate hikes have not been passed on to savings accounts and CDs so a core source of bread and butter earnings is definitely more profitable certainly for those that have retail businesses. It's also true for those that have some sense of history of the sector that when we run into sort of a sticky period for economic growth companies anxious to sort of maintain profit levels will look to buy growth. And they, as a result of the interest rate trends in recent years, a lot of them have pretty fat war chests. Raising capital also you know despite the higher rates still doesn't seem to be tremendously daunting. So while nominal monetary conditions are tightening sort of real ones are still somewhat behind.

Kirsten Longbottom 08:18
Interesting. So something we haven't discussed on here in a while, Bear Funds which aim to profit from falling markets has attracted attention since mid-June. Want to give our listeners a bit of insight on these funds as well as Leveraged Funds?

Cameron Brandt 08:37
Well, that is obviously a group those two groups you mentioned are ones that we periodically take a look at to sort of see what's going on in the areas of highest conviction. The ones that we mentioned in this week's reports were the ones in those two groups that looked to sort of multiply frequently through borrowed money the investment goal by 3 times. So you know somebody investing in 3x Bear Fund has a high conviction that you know we are in for more pain. And those funds have seen a surge in flows recently, whereas your conventional Leveraged Equity Funds. Flows there have tapered off. They haven't cratered which you know is consistent with a view that people think that the worst may be over but there's a limit to how aggressively they're willing to bet on that.

Kirsten Longbottom 09:48
Interesting, and the last one we'll leave it off with: we talked about the dynamic of Japan, China and Taiwan last week but what about Thailand? How does that country play a role?

Cameron Brandt 10:02
Well, Thailand is very much- its economy is very much influenced by the rhythms of China's economy. Thailand is a noted tourist destination and in recent years increasingly the tourists with the biggest wallets were coming from China rather than the sort of packaged tours from Europe. And both because of China's aggressive Covid policy and because economic growth there is not as rosy as it has been, hopes that that key driver of the Thai economy is going to pick up steam again or consistently being dashed. Thailand is also interesting in that it is an offshoring play but it's more of an offshoring play for Japanese firms. So you know I've actually been expecting funds dedicated to it to fare somewhat better than they have because in the longer term there's no doubt that a lot of major global businesses are sort of revisiting their supply chains and where to base them. And Thailand has a proven track record in that particular arena.

Kirsten Longbottom 11:36
Great. Well, thank you for your insight Cam!

Cameron Brandt 11:39
Good, alright stay on your paddleboard.

Kirsten Longbottom 11:44
I'll try my best.

Cameron Brandt 11:46
Something I have spectacularly failed to do on the rare occasions I've been lured on to one. We'll look forward- I mean one of the advantages of podcasts is they won't be able to see any bumps and bruises on you. 

Kirsten Longbottom 11:58
Yeah, exactly I'll give an update next week.

Cameron Brandt 12:02
Good. Alright, enjoy the weekend.

Kirsten Longbottom 12:04
You too. Bye.