- Markets are delicately balanced as investors struggle to weigh whether rate hikes and inflation are priced in.
- Phillip Toews of $2.2 billion firm Toews Asset Management believes markets are at risk of falling much further.
- He told Insider why he has moved virtually all of his company’s money into cash and when it will return to stock.
Markets are delicately balanced this week as investors struggle to weigh whether or not the Fed’s interest rate hike cycle is priced right in the markets.
The bull case is based on the view that because the Fed has been so clear about its plans for the rest of the year, the market has already discounted shares by an adequate amount to reflect tighter financial conditions.
There are also encouraging signs that the economy can withstand higher rates, such as high job numbers and healthy vacancy rates.
However, not everyone subscribes to this point of view. Phillip Toews, CEO of $2.2 billion Toews Asset Management, sees markets at risk of falling further. His conviction in this is strong enough to move the assets under his watch to 90% cash in preparation for lower prices.
This is not the first time Toews has taken money out of the market in anticipation of a downturn. Correctly reduced exposure in February 2020 to avoid much of the downside of the COVID crash. He was also able to trim his stock position before the worst of the 2008 global financial crisis.
Toews said his investment process is driven by computer algorithms, and the picture they currently paint is not a good one for stocks.
“What the algorithms are designed to do is to react in the early phase of a bear market and take a backseat. We are now completely in cash and the interesting thing about this scenario is that when we move defensively, we have the ability to be in investment grade bonds or short duration bonds, but even all of those positions are now in cash.
“So we’re completely on the defensive and our outlook is mostly based on valuations, but also all the things that we know are going on with Ukraine and inflation. We’re going to see a complete turnaround.”
in broader US indices like the S&P 500 this year.
Toews sees the relationship between inflation and financial assets as fraught with risks and potential downsides, and this largely explains his current position. He believes stubbornly high inflation has yet to be priced in properly, and if it remains high, stocks could fall further.
“We looked at the last three episodes of significant cumulative inflation in the US and there were three moments before what we’re experiencing now where average inflation doubled. So what happened to financial assets? It’s really informative in terms where are we now?”
The time periods Toews refers to are 1915-1920, 1941-1951, and 1973-1981.
“Well, obviously, bonds did very poorly on average and stocks on average matched inflation. So they didn’t provide any gains above inflation, but they did at least match inflation on average. But within that average, once it rose. The other twice, the stock fell in real terms.”
“But here’s what’s interesting,” Toews continued. “Throughout the three episodes of high inflation, stocks sold off considerably as inflation went from benign to rampant. So I think if you look at the history of what happened with inflation combined with high valuations and the problems with Ukraine, possible global food shortages and all of these issues add up to a very gloomy picture for the equity markets.”
Some market experts expect the Fed to react to a stock market decline by becoming more dovish, but Toews warned they shouldn’t count on that. He explained that the appearance that the Fed stepped in to support markets in the recent past does not mean that they can or will this time because of inflation.
In terms of going back to the market, there is no magic number Toews wants to see the S&P 500 or the Nasdaq fall to. Instead, he says the decision hinges on seeing stock valuations in a better place and a reversal of market momentum to the upside.
“We’re algorithm-driven, so we stay on the sidelines as markets move lower. When we say we’re bearish, we look at the history of what’s happened in the past. Looking at when we’ve seen high valuations before, we’d still be in the early part of this decline,” Toews added.