What’s next after stock-market bubbles and Archegos chaos mark trading in 1st quarter ?

No one seems to know, but investors were unruffled by the warning signs sounded by the flameout of Archegos Capital Management last week. The ripple effects of the implosion of the family office of Bill Hwang, a protégé of famed investor Julian Robertson, could deliver a $10 billion hit to the banks that were part of a series of complex bets using heaps of borrowed money made by the family office, according to a report by JPMorgan Chase & Co. JPM, +0.97%.

Credit Suisse CS, +0.94% and Nomura NMR, have said that they expect to incur losses due to market volatility believed to be associated with Archegos. Even Wells Fargo WFC, +1.43%, wrestling with its own reputational dings, was involved in the complex trades but has stated that it doesn’t foresee losses due to the $30 billion unwind of Archegos wagers.

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Hwang, a professionally trained, veteran investor, is hardly one to be likened to the collective of individual investors who congregated on Reddit and Discord chat boards to propel shares of so-called meme stocks like GameStop Corp. GME, +0.86% and AMC Entertainment Holdings AMC, -8.33% to breathtaking heights in the first quarter. Yet Hwang reportedly applied a similar playbook to that employed by the retail raiders.

The Wall Street Journal reported that the Archegos founder routinely made concentrated bets within his portfolio that made his returns volatile and that he “liked to focus on stocks that were heavily ‘shorted,’ or had a high level of bearish positions,” citing a person familiar with the investment manager’s trades.

If that strategy sounds familiar, that is Reddit investing 101.

And it turns out that otherwise staid family offices have become a much riskier part of the market, embracing “investment strategies used in previous decades by the most aggressive hedge funds,” WSJ’s Gregory Zuckerman reports, with 69% of these offices established over the past two decades perhaps as regulatory scrutiny on hedge funds intensified.

To be sure, the Archegos story doesn’t appear to be a redux of Long Term Capital Management, which suffered seismic losses in 1998 that sent shock waves throughout global markets, but the event does come at a precarious time for investors and continues to point to froth building up in the financial system amid interest rates that remain historically low and liquidity that is nearly unceasing.

A separate JPMorgan report dated March 30 said the Archegos blowup does raise eyebrows. “The Archegos events raise questions about leverage in the financial system,” wrote analysts including Nikolaos Panigirtzoglou.

JPMorgan’s conclusion is that hedge fund leverage, in particular, has risen again since 2017 “and currently stands at the highest level since 2007,” but notes that the levels of borrowed funds remain significantly below the historic high levels around the Long Term Capital Management crisis.

Still, MarketWatch also has been curious about investors’ knack for dismissing calamities like Archegos and turbulence fueled by Redditors.

“The market is well positioned to handle things like this with all the liqudiuty being provided by the Fed,” Jeff Buchbinder, equity Strategist at LPL Financial, told MarketWatch in a Friday interview.

Buchbinder said that the market didn’t perceive either GameStop nor Archegos as systemic risks, and grave concerns about the integrity of financial markets would have been perceived in widening credit spreads, reflecting the differential between what businesses pay to borrow money compared against the government.

Bond yields also maintained an upward trend in the first quarter, as investors continued to rotate out of risk-free debt and into assets that could perform better as the economy recovers from COVID. The 10-year Treasury note yield TMUBMUSD10Y, 1.719% ended the week at 1.714%, with the bond market closing early at 12 p.m. Eastern in observance of Good Friday.

Buchbinder says that investors are more concerned about the Federal Reserve, inflation, and the outlook for the economy than they are about hedge-fund-like implosions and Redditors.

“Something we haven’t seen is inflation and a lot of people are worried about an inflation scare,” the analyst said.  

The expectation for a surge in consumer prices come as the U.S. economy added 916,000 new jobs in March, well above the average forecast analysts surveyed by Dow Jones for 675,000, with the unemployment rate falling to 6% from 6.2%.

Some fear that those healthy figures portend a surge in the jobs market that could compel the Federal Reserve to rethink its projections for when easy-money policies will be normalized, currently at around 2023 and 2024,

“The Fed’s timetable probably has to move up a little but the market never really believed that they would wait until 2024 before raising rates, anyway,” Buchbinder said.

The LPL analyst said that the bigger fear—one that the market may not immediately be ready for—is tapering of the Fed’s bond-buying by as soon as the fall of this year.

Aiding the economic rebound is $1.9 trillion in COVID aid from Congress that is being doled out to small businesses and individuals reeling from the pandemic. President Joe Biden’s $2.3 trillion infrastructure proposal, which would also come along with tax hikes, could further juice the economy even as it potentially slows down the bull market in stocks with increased borrowing costs.

Read: These infrastructure stocks could rise up to 41% in a year on Biden’s massive spending plan, analysts say

“The market will be concerned about the Fed most likely and that could slow this [stock-market] advance as we price in this economic recovery in the spring,” Buchbinder said.

What are investors to do against that backdrop?

LPL is still advising that a healthy dose of value, equities viewed as undervalued versus a metric such as book value, should be in investors’ portfolios but also believes that select growth-oriented stocks, which promise above-average earnings growth, will perform well over the longer term as well.

In fact, Louis Navellier, founder of asset-management firm Navellier & Associates, says that semiconductor companies, despite issues with chips, could be a good bet in 2021.

“High-tech companies that are crucial suppliers to cyclical companies stand to benefit hugely from the economic rebound, arguably more so than the companies they supply,” Navallier wrote in a research note dated April 1.

“The takeaway is that regardless of the ongoing growth versus value debate, the chip and chip equipment sector can claim to be both value and growth,” he writes.

“In the near term, value probably has a little bit of an advantage,” said Buchbinder estimates. The LPL analyst also said that investors should not be fearful of owning bonds as yields climb and prices fall because they still represent protection against bumps in the stock market ahead, particularly if the 10-year yield rise is capped at around 2%.

Durations, however, should be kept short, with LPL advising maturities of three to five years in fixed-income.

On Thursday, with the U.S. stock market closed on Good Friday, the S&P 500 index SPX, +1.18% clinched its 16th record close of 2021, while the Dow Jones Industrial Average DJIA, +0.52% marked its second-highest finish in history, off less than 0.1% from its all-time closing high at 33,171.37, notched earlier last week. The yield-sensitive Nasdaq Composite COMP, +1.76% is 4.4% from its Feb. 12 record high.

So, will this Wall Street party last forever ?

“At some point the Fed is going to take away the punchbowl,” said Buchbinder and maybe then events like Archegos will matter more to markets.