Tech and growth-focused stocks have dominated markets for over a decade, but a paradigm shift is coming as the Federal Reserve raises interest rates to fight inflation, according to Steve Eisman, senior portfolio manager at the Neuberger Berman Group. Eisman rose to fame for his successful bet against subprime mortgages in the lead up to the Great Financial Crisis (GFC) of 2008, which was depicted in Michael Lewis 2010 book, The Big Short, and the subsequent movie of the same name, in which a character resembling him was played by Steve Carell.
Markets have long periods of paradigms where certain groups are leaders, the hedge funder told Bloomberg in an episode of the Odd Lots podcast Monday. Sometimes those paradigms change violently, and sometimes those paradigms change over time, because people dont give up their paradigms easily. And I think were going through a period, possibly, like that again. Eisman pointed to Thomas Kuhns 1962 book, The Structure of Scientific Revolution, as evidence that markets may be undergoing a gradual, yet volatile paradigm shift.
When Einstein created his theory of relativity, for exampleIts not like everybody said, Oh, weve been waiting for Einstein, thank God, now we can get rid of Newton. It took several years for people to realize that that was a better theory. I think something like that happens in markets, he said. Paradigms are so deeply ingrained in peoples brains they cant even imagine, at times, that there could be anything else.
After years of soaring tech stocks and cryptocurrencies, George Ball, chairman of Sanders Morris Harris, a Houston-based investment firm, told Fortune in December that he also expects a paradigm shift in markets this year as investors take a more conservative approach.
I think you occasionally get a turning of the investment and economic age, and were at one of those now after over a decade of near-zero interest rates, he said. Periods of euphoria need to be followed by periods of abstinence.
The old and the new
With the Federal Reserve holding interest rates near zero for so many years after the Great Financial Crisis and during the COVID-19 pandemic, tech and growth stocks outperformed the overall market.
Low borrowing costs allowed these firms to readily invest in revenue growth and a lack of viable alternatives to equities due to low rates meant investors were essentially paid to take risk and invest in them, Eisman said. On top of that, many investors were suffering from Amazon disease, according to the hedge funder. By this he meant that the success of tech giants like Amazonsome of which were unprofitable for years before their stocks soaredled to an era of speculative investing in growth-oriented stocks over the past decade.
From 2010 through the beginning of 2022, if you were a company that had no earnings but strong revenue growth, people dreamed the dream, Eisman said, arguing that investors were always looking for the next Amazon, and often ignoring fundamentals in the process. But now, with rates rising, Eisman said he believes revenue growth at many of these firms is now slowing and a new era is coming for investors.
He described how former stock market leaders were overtaken during past market paradigm shifts like the one happening now, noting that the financial stocks which outperformed before 2008, literally did nothing until 2020.
Call it a dozen years where the old leadership group evaporated, he said.
The hedge funder went on to argue that the rise of the growth and tech stocks that were market leaders to start the year is an example of how people dont give up paradigms easily. The tech-heavy Nasdaq is up more than 13% year-to-date, and Cathie Woods ARK Innovation ETFwhich focuses on tech and growth stocks and became a bellwether for the sector during the pandemicis up more than 37%. Eisman warned this could be the last hurrah for these stocks, but added that it depends on the Federal Reserve.
[Federal Reserve Chair Jerome] Powell has said that hes going to keep raising rates, and the important sentence is, and hell leave them there. If he leaves them there, I think well have a paradigm shift. If he cuts again, well go back to where we were, he explained. I think hes going to leave them there and well have a paradigm shift, but its unknowable at this point.
This isnt 2008
While Michael Burry, another hedge funder made famous by the success of The Big Short, has argued that stocks are in the greatest speculative bubble of all time since 2021 and predicted the mother of all crashes, Eisman doesnt believe history is repeating itself. Improved regulation in the financial system has created a much safer system, he argues.
I think 2000 and 2008 for some investors is like PTSD, he said. There arent 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.
And while Burry has warned that an extended multi-year recession is likely on the way, Eisman said hes expecting something much more mild.
Something bad could happen, you know, we could have a recession, he said. But my feeling is well have an old-fashioned run-of-the-mill recession. Were not going to have some enormous meltdown crisis where the system is completely at risk, which is what happened in 08.
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