Good-Bye Relaxing Merry-Go-Round And Hello To The More Volatile Roller Coaster Of Financial Life

Many of us may have been lulled into a false sense of ongoing super low interest rates and virtually non-existent volatility. It was only a matter of time before reality returned and the fact that it took as long as it did reflects the depth of the decade-ago crisis and the magnitude of the medicine that was administered to get the patient off of life support. When the transition takes this long, it is easy to lose perspective and begin to believe that calmly going round and round in a relaxing manner while enjoying cotton candy is the real world, and the sharp climbs and sudden plunges are the anomaly, but in our collective 60+ years of experience, we know this is not true. We would like to share with you our thoughts, experiences and observations regarding the return to “normalized volatility,” and perhaps some of its implications and realities:

1. If you started work in the financial sector (hedge fund, private equity, investment banking, research, sales and trading) in the past ten years, you have no experience with what happens in a rising interest rate environment. Remember, a decade is a long time and this means some of the people who never experienced high or even mid-level rates have been promoted to important positions within their respective firms. This is a large group of smart people who have never experienced a Fed that isn’t our short-term friend. Unsurprisingly, some may have limited appreciation for a Fed that is concerned with moderating future inflation (what’s inflation?), managing a deficit (why should we care—just keep printing baby!) or having enough ammunition to cut rates the next time we have a recession (haven’t technological gains made future recessions obsolete?). The last decade is NOT the norm with rates or volatility and every one of us needs to open our history books either for first time learning or a refresher course, depending on your years of experience.
2. Increased volatility can also be a good thing, as long as you survive the transition. Super low interest rates with non-existent volatility make it almost impossible for good investors (or sell side professionals) to differentiate themselves. Correlation is high in every asset class, and stock pickers, credit professionals, underwriters, researchers and traders have a hard time distinguishing themselves or competing against benchmarks. These days may be over for quite a while. This is really good news for those who can truly add value, but may mark the end of the line for any marginal players who were helped by merely surfing a nice wave.
3. There are concepts called distressed cycles, covenants, violations of covenants, recovery value of secured versus junior debt securities, illiquidity, waivers, and restructurings. Rates do go up, the economy sometimes cools, liquidity isn’t a God-given right and operating margins sometimes shrink. So yes, sometimes life does get less fun and more complicated. We are not saying this is going to happen overnight and it is “game over.” In fact this could be quite a distance away. We are saying that all of these “historical concepts” are real and not a figment of hypothetical imagination. Fortunes are made by those who navigate these waters properly and they are lost by those who rely on yesterday’s calm sailing.
4. Increased volatility doesn’t mean one should fully de-risk and sit in cash while waiting for the lightning to strike everyone else. The world keeps turning. Political risks that look terrible sometimes change on a dime and all is temporarily fine once again. The Fed is smart and they also realize that sometimes they have to moderate their work to optimize long term value by balancing the reality of short term needs as well. They might have done just that this past Wednesday. Technology and innovation do help and productivity gains can help offset a lot of other problems or mistakes. This all means that it is best to just be balanced. If you loved FAANG stocks for all the right reasons, you really can’t hate them all now that they are 35% cheaper. Even with rates up quite a bit, they are still relatively low by historical standards, and credit is priced much more attractively today than any time in recent history. Perhaps it just means it is time to be more selective, pick your spots carefully and, when stepping out on the risk spectrum, make sure the structure is right and the upside justifies the increased risk environment. Diversification is always good during these periods of inflection, and a healthy cash position allows one to be more nimble, deal with any redemptions from the faint-hearted and be even more aggressive when the right opportunities surface. All of these investing points also relate directly to our strategies and decisions for our investment banking, sales and trading, and research teams at Jefferies.

Yes, all of our worlds are getting more complicated, challenging and volatile. This is not a “shock to the system” but a return to the normalcy of complex markets reflecting an uncertain world. Let’s work together with our clients to embrace reality and show them why they can rely on all of us at Jefferies to be the ones who can keep a calm perspective, be honest in our assessment of the current environment and be their best partners in helping them continue to add value to their stakeholders—regardless of the environment.
Happy to be on the roller coaster with each of you. Buckle up!

Rich and Brian