Points of Return
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Today’s Points:

Where Are We Going?

In the climactic scene in Trading Places — easily the funniest film about commodity trading ever made — Mortimer Duke realizes he has lost his fortune in the day’s trading, and screams, “Turn those machines back on!”, thinking that if trading could only start again, things would go back to normal. Larry McDonald of Bear Traps Report offers this as a market analogy:

Today’s US equity market backdrop reminds us of this delusion. Much of the Wall St. sell-side research community doesn’t realize we have moved to an entirely new regime… The mad mob thinks we can simply ‘turn those machines back on,’ not realizing we are far, far, far away from that lost world. 

Traders behaved last week as though they could hit the usual on-switch, after the spasm that greeted the Trump 2.0 agenda. The rally was potent, aided by confirmation that Jerome Powell wouldn’t be fired as chair of the Federal Reserve, more emollient noises about tariffs on China, and a generally good start to the earnings season. It even triggered the Zweig Breadth Indicator for only the 18th time in 80 years, an almost foolproof bullish signal for the next 12 months; it only happens when when the share of stocks that are rising moves from less than 40% to more than 61.5% within a 10-day period. In other words, this rally lifted a lot of boats, and left many pointing in a positive direction. 

The recovery of the VIX index of volatility since the April 9 announcement of a 90-day delay on tariffs has been a sight to behold:

The tariff regime still on the books remains considerably worse than what was regarded as the worst-case scenario a month ago, but nobody trading the market on a short-term basis can afford to ignore signals like this. Risk appetite and liquidity suggest that risk assets can continue to move higher for now. That’s true whatever the long-term destination might be. 

Viewed in only a slightly longer context, the S&P 500 is essentially, as the Duke brothers might have wanted, back where it was a year ago. This is true whether you compare it to bonds (proxied by the TLT exchange-traded fund, which tracks Bloomberg’s index of long treasuries), or to other stock markets (proxied by the MSCI All-World excluding US index). 

Within the stock market, what had seemed a clear turning point is now murkier. This is how the Magnificent Seven have fared compared to the average stock in the S&P 500 since the turn of the decade:

The toppling of the Magnificents seemed obvious a month ago, but now it’s more ambiguous, as they keep returning to their 200-day moving average relative to the average stock. Their upward trend has been corrected for post-election excess, but it’s not been ended.

Some changes have lasted, starting with expectations of the Fed. The chart shows the number of rate cuts that had been priced in at the turn of the year, on April 8 — the point of maximum angst before Donald Trump delayed tariffs the next day — and currently. Markets expect the Fed to cut far more aggressively now than they did before Trump took office. That hasn’t changed since the tariff reversal, other than that early emergency cuts seem less likely:

The reason for this: Traders think a recession is far more likely. At present, they expect the Fed to hold off cutting for a while until the inflationary impact of the tariffs is clear, and then slash rates about five times. Such a pattern only makes sense if a slowdown takes hold. Lower rates historically help equity prices, of course, but not when they’re a response to a weak economy. Rightly or wrongly, most investors are working on the assumption that even if tariffs come down significantly, they will still be too heavy to avoid a recession. 

Meanwhile, the dollar’s decline hasn’t been arrested. In some ways, this is still not that big a deal. On a broad trade-weighted basis, it remains higher than for much of this decade, and its decline isn’t as strong as the fall after the Covid panic of 2020, nor after US inflation peaked in 2022:

But this ignores the fact that both those declines came as risk appetite returned after fear had driven money into the dollar as a haven. This is different. Fear is rising, and the dollar is still selling off. That implies broken confidence in the US, which has been a dominant narrative for weeks. The idea of American exceptionalism built up in markets over decades, and had grown extreme in the five years since the pandemic. That cannot be priced out in a few weeks, and markets won’t move in a straight line as funds leave the US. Julian Brigden of MI2 Partners argues:

The disruption caused by the Trump administration’s assault on geo-political and economic norms would/will have started a new, secular ball rolling where faith in American exceptionalism will be broken beyond repair. BUT, that doesn't mean we shouldn’t be flexible enough to take profits and reset positions into the inevitable counter-trend correction when we reach climactic narrative adoption.

Last week saw a potent “counter-trend correction” as people took an exciting narrative too far and too fast. Whether it comes true depends on where policy moves from now, and the reactions to it. If almost all the announced tariffs are repealed and China and the US thrash out an accommodation, while Washington resumes enthusiastic support for Ukraine and works closely with European allies, then things will begin to look very different. The mood music of the last few days suggests that all of this is just about conceivable. Tax cuts on top — which Trump is sensibly returning to the conversation — would juice things up further.

Dan Aykroyd about to disrupt the commodities machine.
Source: ‘Trading Places,’ 1983/Paramount/Archive Photos/Getty

Judge for yourselves how plausible that scenario is. Trump doesn’t admit errors, so it will be hard to achieve. Meanwhile, the overwhelming sentiment, particularly outside the US but also on Wall Street, is that a Rubicon has been crossed, and trust in the US irretrievably damaged. Arguably, even the the scenario I just mapped out wouldn’t restore it.

Evidently, many still believe the machines can be switched back on. They shouldn’t be ignored, and trading never goes in a straight line — but it would make sense to take last week’s bounce as an opportunity to continue positioning for the gradual decline of American exceptionalism.

Harvard vs. Yale vs. Private Equity

Some of the most potent political conflicts of the day are combining to create big trouble for Ivy League universities and, in their wake, the private equity industry. What appear at first glance to be rather technical financial stories last week on efforts by Harvard and Yale to cut their exposure to private equity show the confluence of several trends that have driven discord and inequality within US society.

Universities as a whole are under pressure, because the four-decade increase in tuition fees, far ahead of overall inflation and impervious to recessions and financial crises, had grown unbearable. Covid-19, when students left campus, was the crisis moment. Since then, tuition fees have risen only slightly, far behind overall inflation, as college at last has to justify itself as an economic investment. But as the Bureau of Labor Statistics shows, this could have much further to go:

Tuition may have stopped inflating so fast, but Bloomberg colleagues show that now even families with $300,000 in annual income — a level most would call wealthy rather than just middle-class — struggle to meet the fees unaided. The Ivy League, elitist and privileged, is under specific attack from the Trump administration, which is withholding all federal grants from Harvard. The legality of this and other measures will be thrashed out in the courts. In the meantime, America’s most famous universities will need money if they want to stare down the federal government.

Tuition income is already under threat. If the schools lose out on federal grant money as well, they’ll likely need to fall back on their extremely rich endowments. Theoretically, that should be no problem at all. This is the breakdown of where Harvard gets its money, as reported by the Wall Street Democrat newsletter:

The endowment, worth some $53 billion, has the resources to cover these shortfalls. The problem is that the schools need to get their hands on them. For decades, the Ivy League endowments have followed different variants of the Yale Model, so-called because it was initiated by Yale under the late David Swensen. His insight was that the endowment had an infinite time horizon, and could therefore afford to take more liquidity risk than others. Profitable mispricings are more common in illiquid and inefficient markets, and so Yale dove into them, followed by others once the strategy’s  success grew clear. 

Those successes attracted the attention of other big institutions. The endowment’s investment returns, combined with the allure of the Yale brand, made it safe for investors to pile in. They even weathered terrible results during the crisis of 2008, when some of the biggest endowments were forced to take out loans to meet their commitments. 

The Lowell House on the Harvard University campus. Photographer: Sophie Park/Bloomberg

Now, the Ivies’ need for liquidity has suddenly risen. Both Yale and Harvard are trying to sell significant portions of their private equity portfolios. As they were so important to the rise of the asset class, it’s fair to ask, as Marc Rubinstein did in Bloomberg Opinion, whether this signals Peak Private Equity.

Just as the universities face this moment of truth and their customers are questioning their fees for the first time in a generation, so the same is happening to private equity. Sentiment has been challenged ever since central banks began raising rates in 2022. The PE business model relies on leverage, so this was a problem — and indeed Yale’s returns have slipped thanks to its heavy exposure. As Points of Return has reported, the smaller endowments, unable to invest in illiquid assets with their big minimum investments, have of late been outperforming the Ivies. It’s turning into an advantage not to be saddled with private equity. Shares in the biggest listed PE providers worldwide have far underperformed equivalent shares in banks, and the market as a whole:

It’s fair to take listed private equity as a proxy for confidence in the sector as a whole. But, as with the most famous Ivy institutions, it’s possibly more important to look at sentiment toward the biggest and most famous player, Blackstone. It feasted on the Fed’s decision to leave rates at zero throughout 2021, and then surged to new peaks relative to the market as it grew more likely that Trump would win. The fact that founder and CEO Steve Schwarzman was one of the more enthusiastic Trump-backers in the world of finance stoked the mood. But since the inauguration, Blackstone’s fall from grace has been spectacular. 

If the Ivy League is a bête noire for conservatives, then the private equity industry occupies a similar place in the mind of liberals. If big investors start asking for their money back, there is the risk of a negative cycle taking hold. It grows harder for Big PE to raise funds, and pressure rises to make disposals. Like universities, PE funds have been able to get away with setting more or less any price they want for years. That seems to be coming to an end. And as most are offering big paper profits to their investors, the temptation to sell now will be high.

Just how Yale and Harvard go about their task over the weeks ahead could be crucial for sentiment in the entire sector. And the longer the struggle with the feds continues, the more they’ll need that liquidity. This is a crucial nexus for markets. 

Survival Tips

America has a complicated relationship with Harvard. The nation’s wealthiest and most respected university is also widely disliked. The satirist Andy Borowitz even suggests that Harvard should give the president an honorary doctorate for his “game-changing service” in “making Americans like Harvard.” Its handling of the Gaza protest movement has been dreadful, and prompted much conflicted but fascinating commentary from alumni: Bill Ackman offered a huge essay on “how to fix Harvard,” the Wall Street Democrat offers an impassioned defense of the university as an engine of social mobility; and the New York Times’ David French summons up his anger with his alma mater and even greater fury with the government attack on it. It’s all worth reading. Have a good week everyone.

More Charts on the Terminal from Points of Return: CHRT AUTHERS

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