After years of tech stock dominance comes the painful process of moving onto something new.
(Bloomberg) — Don’t be fooled by the recent rally in everything from tech stocks to crypto, says Steve Eisman.
The Neuberger Berman Group portfolio manager, who famously bet against subprime mortgages right before the global financial crisis, sees an oncoming market regime shift in the higher interest-rate era, with new leaders replacing the big companies that have dominated the investment landscape over the past decade or so.
“Paradigms change over time,” Eisman says in the latest episode of the Odd Lots podcast. “Sometimes those paradigms change violently, and sometimes those paradigms change over time because people don’t give up their paradigms easily. And I think we’re going through a period possibly like that again.”
New winners may include firms tied to “the reshoring of the industrial world back to the United States” and “greenification,” per Eisman.
His words serve as caution at a time when expectations of a slower pace of rate hikes by the Federal Reserve are breathing new life into assets that were crushed last year. “Some of those stocks are up 50 to 60%,” Eisman says. “It’s astonishing.”
He cites Thomas Kuhn’s 1962 book The Structure of Scientific Revolutions to help explain the sometimes wrenching and prolonged process by which one regime is replaced by another: “When Einstein created his theory of relativity, for example … It’s not like everybody said, ‘Oh, we’ve been waiting for Einstein, thank God, now we can get rid of Newton.’ You know, it took several years for people to realize that that was a better theory. I think something like that happens in markets.”
Eisman describes previous paradigm shifts, including the transition from big conglomerates like General Electric Co. in the 1990s to the technology firms of the dotcom bubble and financial stocks of the early 2000s. The dominance of banks famously came crashing down in 2008 but even then, he notes, some financial names rallied in 2009 and 2010. Eventually, he says, a prolonged period of low interest rates shifted investor focus in favor of growth equities like Amazon.com Inc.
“When rates are zero, you’re paid to speculate,” Eisman says. “People are always looking for the next Amazon. And you know that they’re looking for the next Amazon when the sell-side writes a research report and the first sentence is ‘the TAM is huge,’ which means the total available market is huge.”
But eventually dreams of gigantic TAMs start to fade as both businesses and investors run head first into reality. “2010 through the beginning of 2022, if you were a company that had no earnings but strong revenue growth, people dreamed the dream. When the revenue growth slows, people stopped dreaming the dream, or a combination of that with higher rates and the discounting mechanism takes down the stock,” Eisman says.
To some extent, whether we see a complete shift in market leadership is dependent still on the Fed — and if Powell keeps his word about not cutting rates imminently. “If he leaves them there, I think we’ll have a paradigm shift. If he cuts it again, we’ll go back to what we were, which is growth stocks… I think he’s gonna leave them there and then we’ll have a paradigm shift,” says Eisman.
As a hedge fund manager at FrontPoint Partners LLC, Eisman made his name betting against subprime loans before the housing bubble began to burst in 2007, as chronicled by Michael Lewis in his book The Big Short and made into a movie of the same name in which he was portrayed by Steve Carell. Eisman later launched his own fund, Emrys Partners, which he shuttered in 2014.
Eisman says he sees little chance of a repeat of the 2008 financial crisis with the majority of US banks now much less levered than they were before.
“I think 2000 and 2008 for some investors is like PTSD,” Eisman says. “Financials are complicated. There aren’t a lot of people on Planet Earth who really understand how much the financial structure of the United States and Europe has really changed. So they see the markets go down and they say to themselves, ‘Oh my God, something bad is going to happen.’”
One area where there is a lot of post-traumatic stress is in housing, but even here Eisman doesn’t see the recent surge in mortgage rates sparking the kind of liquidations and fire sales that occurred some 15 years ago:
“I did a small calculation when mortgage rates got to 7%, which was if you calculated the monthly payment of someone who bought a home with a 3% mortgage versus someone who wants to buy the same home at the same price, with the same mortgage at 7%, for that person to have the same monthly payment as the person with a 3% mortgage, the price of the house has to go down from like 30% to 35% to 40%.”
That could, in theory, set the housing market up for a big plunge. Except the difference this time round, Eisman says, is the employment picture. “As long as people are employed, they’re not going to sell their home down 40%.” In this scenario, that means the housing market is frozen for now, rather than poised for another big crash. Instead of selling their homes and moving to something bigger, families will instead just stay put.
“Now something bad could happen, you know, we could have a recession,” he adds. “But my feeling is we’ll have an old-fashioned run-of the-mill recession. We’re not going to have some enormous meltdown crisis where the system is completely at risk, which is what happened in ‘08.”
Meanwhile as new leadership drives the market, the transition will likely be particularly painful for people who built their identities by being bullish on things like crypto, meme stocks and tech names. Of course, the investors who called the Great Financial Crisis correctly have also had to grapple with big changes to the market landscape that challenge their world view.
Asked why he’s been able to move on from predicting market and financial system crashes, while some others who also made their names during the dramatic events of 2008 continue to do so, Eisman quipped: “a lot of therapy.”
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