October 2, 2023

Top hedge fund chief sees S&P 500 enter ‘No Man’s Land’

(Bloomberg) — Bill Harnisch is on a roll. Assets in his Peconic Partners hedge fund are soaring thanks to near-perfect market timing, including shorting last year’s bear market and pivoting long just as the tide turned.

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So if he says the party is over, that’s worth considering.

Up 35% this year after a 26% rise in 2022, Peconic sits with $1.5 billion in assets and a growing belief that the tech rally that fueled the latest leg has had its best days. The New York-based fund recently sold all of its shares in Alphabet Inc. and Amazon.com Inc. dumped — names that made up more than 10% of its holdings — and is preparing for a slower slog in stocks after adding $9 trillion in stock values ​​in nine months.

“We entered a no man’s land because it didn’t break down and it didn’t break down,” Harnisch, who started in the financial industry in 1968, said in an interview. “I can’t sit here and tell you I’m not surprised how well the market has done since interest rates haven’t fallen. But I struggle to see where the big impetus for future growth lies.”

With the S&P 500 hovering around 4,500, the top end of its forecast range for the next one to two years, the former Chase Manhattan Bank analyst admits the market could overshoot, especially if optimism about artificial intelligence and an end to the Federal Reserve tightening continues to build. But after a 26% rally, he says, the market has yet to prove itself at this high, which is still below the high it reached in early 2022.

The veteran sees a slew of potential headwinds, from continued inflation to disappointing earnings and tense valuations. He says the opportunity for the S&P 500 to retest the October low of 3,500 is not light.

As Harnisch sees it, companies like Alphabet are acting as if AI could revolutionize the way people live and work overnight. But innovations like theirs existed long before Microsoft Corp. $10 billion invested in OpenAI, owner of the recently launched AI tool ChatGPT, and even pioneer Alphabet proceeded with caution.

“Everyone was shocked to see Microsoft getting serious about AI – it’s going to change the world, so buy a ticket and jump on board.” says Harnish. “It’s real, it’s big, but it’s going to take a long time.”

His caution stands out at a time when bulls are tightening their grip on the market. It comes from a manager that has grown 60% annually in the three years through June, four times the S&P 500.

Of course, Harnisch’s view of the market wasn’t exactly positive at the start of the year, with predictions that the S&P 500 would trade in a range as 2023 unfolded. With stocks pushed to the top of that band, he’s pulling back, curbing leverage and diversifying away from technology.

Peconic, which started in 2004, employs a dozen people who try to figure out which companies will grow faster than the economy in the long run. The picks, the core of his portfolios, are usually held for seven to eight years. On the short side, the team is building hedges to offset risk from core holdings while looking for mispriced stocks.

The team recently acquired MasTec Inc. added, a construction company, which is expanding a selection of industrial holdings expected to benefit from growing demand for high-speed internet, clean energy and AI infrastructure, areas where the government plans to increase spending and reduce regulatory bottlenecks .

MasTec shares gained 25% in the second quarter. Two of the fund’s largest holdings – power cable builder Quanta Services Inc. and Wesco International Inc., a distributor of electrical equipment – are up 39% and 42%, respectively, year-to-date.

All told, Peconic’s net leverage — a measure of risk appetite that takes into account long versus short positions — currently stands at 32%. That’s about the midpoint of a three-year range and lower than the 2023 peak of 45%.

Now Harnisch is grappling with a market he calls “fully priced.” The S&P 500 is valued at about 19 times next year’s expected earnings, an estimate that is close to $240 per share and represents an 11% increase, according to Bloomberg Intelligence. Although the asset manager does not expect an economic recession, such a rapid recovery in corporate profits seems overly optimistic.

The rise in equity multiples is further weighed down by the trajectory of interest rates, which he expects to remain high for longer as inflation, despite years of downward trend, is likely to remain above the Fed’s 2% target, underlined by continued wage pressures and a rebound in oil prices. Prices.

That said, the stock has defied gloom warnings throughout the year and stayed afloat. Since early March, the S&P 500 has managed to avoid a 2% weekly decline, the longest period of resilience in nearly two years.

Harnisch says his company will closely monitor the second-quarter earnings season, which is in full swing in the coming weeks, for changes in patterns in everything from consumer spending to wage pressures and growth in China.

“We’re just waiting to see how the news comes out,” he said. “As people say, we’ll watch and see how the cards come out of the deck.”

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