mattee2264

We haven't seen major wage inflationary pressures yet because the data is backward looking and people can only bargain for wages annually and it takes a little while for people to realize that their living costs have gone up and therefore their real wages have fallen. But I imagine this December/January most companies will be forced to give major pay increases to keep their staff happy and that will add additional fuel to the inflationary fire. And really this is what worries people. The root causes of inflation are reasonably temporary (i.e. excessive fiscal and monetary stimulus and supply chain issues and pent up demand from the pandemic) but even as those factors fade in significance because companies and workers have experienced higher costs they adjust by increasing prices and wages and a wage-price spiral can begin that perpetuates inflation. Of course it wont be as bad as the 70s because we are not as unionised or labour intensive but it could still be problematic and require higher rates for longer. People seem to be assuming that higher interest rates are temporary and inflation will fade in 2023 and we will go back to low interest rates. It seems to me this could be a parallel error to post GFC when initially people thought that low interest rates were a temporary condition and were too conservative in their valuations as a result. This time round if higher interest rates will similarly persist then market valuations still look unreasonably high.

Yeah I think fundamentals (still trading at 20x trailing earnings which are heading lower and possibly a lot lower) and sentiment (still jacked up on hope-ium believing in a soft landing and an imminent Fed pivot) both indicate the bear market has room to run. There also seems to be a continuing tug of war/whack a mole game between the Fed and the market. The Fed talks tough and markets sell off violently over a week or two. Then there is some economic data that is interpreted favourably or a dovish comment is made by someone related to the Fed and a violent bear market rally.

Well currently at just below 4000 markets are placing a 20x multiple on current earnings. That is a pretty generous multiple when the Fed is telling us rates will hit 5% in 2023 and there seems to be a lot more downside for earnings as the full impact of rate hikes hasn't been felt, inflation is still more of a tailwind than a headwind to nominal earnings and the consumer has been able to stretch to continue spending and the jobs market is still holding up well. With a soft landing type scenario I think markets will trade in the 3400-3800 range with modestly declining earnings weighing on the indices but somewhat offset by speculation that the pause/pivot is coming closer and cheer about falling inflation figures. But I do not expect a V shaped recovery. The economic strength of 2021 was a mirage and even with a pivot credit wouldn't be easy enough to make financial engineering as easy as it used to be. On the other hand inflation is quite helpful in easing the burden (if the market goes sideways in nominal terms but inflation stays in the mid single digits then over a few years valuations become more reasonable). I think the possibilities of this (for the USA at least) are quite high perhaps as much as 50%. So far it does look more like a slowdown as the unprecedented stimulus wears off and consumers and businesses cut back in response to higher costs. That should produce a mild if not brief recession. In a hard landing offset by a pivot/pause/decline in the terminal rate you probably get a slightly lower bottom (maybe 3200) but a faster recovery because it will once again confirm the Fed put which makes it impossible for sentiment to get bearish enough to make proper bear market lows. As in a hard landing scenario inflation probably comes down quite rapidly in 2023 I can see the Fed pivoting pretty damn quickly. I would put this at a 40% probability. I think to go 3000 or below you would need a hard landing AND a Fed which refuses to budge OR some kind of financial crisis. All seems fairly unlikely. Maybe 10% probability.

Investment banks are only just starting to properly slash 2023 EPS estimates. Morgan Stanley saying $195 per share. JPM saying $205 per share. Goldman Sachs $225 per share. This is all pretty consistent with the bear market being far from over with earnings providing the next leg down. I think paying too much attention to the Fed is making markets even more short sighted than usual. People forget that markets usually bottom long after the Fed starts easing. And that doesn't seem to be on the menu for a while now even if the Fed is starting to slow the pace of easing. The 2022 bear market was an inflation/policy shock which is subsiding. The 2023-2024 bear market will be led far more by earnings and policymakers hands are tied to a far greater extent than previous recessions this century.

Interest rates get a lot of attention. But earnings are usually the major driver of cyclical movements. S&P 500 was at 2000 several years ago and S&P 500 earnings were 100. Not S&P 500 is at 4000 and S&P 500 earnings are around 200. The fact that interest rates have gone from basically zero to 3% over this period does not seem to be reflected in valuations even though interest rate movements have had a disproportionate impact on fluctuations over the last several years. If you look at previous severe bear markets they were accompanied by earnings falling off a cliff and Fed cutting rates did little to prevent the collapse in stock prices. Rather markets recovered soon before earnings started to recover. No idea if earnings will fall off a cliff this cycle. But I suspect 200 represents a cyclical peak and is artificially high due to peak margins, peak stimulus and peak animal spirits (to some extent earnings were shifted from 2020 to 2021 due to pent-up demand/excess savings etc). And even a mild recession could bring earnings down significantly. Already this year we haven't seen much in the way of a recession but already Q2 earnings are 20% below the Q4 2021 peak (which not surprisingly coincided with the peak for the S&P 500 and what is most likely the bottom for this year). And we have not even really felt the impact of interest rate hikes on earnings and firms may find it harder going forward to pass on price increases to consumers especially as consumers show signs of being tapped out and job market data always looks best just before a recession. But of course a major factor in stock prices is sentiment and what markets are focusing on. If they keep focusing on inflation and interest rates then bad news is good news and earnings will not matter. But eventually I expect the focus to shift especially if the Fed stubbornly refuses to pivot. The low will probably be when markets start worrying the Fed will never pivot rather than interpreting every half-dovish comment as bullish. But the Fed won't establish credibility overnight and any signs of slowing for now will be interpreted as a sign that the Fed is wimping out and will continue to get more dovish until an eventual pivot

I think the recent market rebound is consistent with the idea that the recession is a 2023 rather than a 2022 story. The 2022 story was about the inflation shock and policy shock from aggressive rate hikes. Those shocks are dissipating as the Fed is signalling a slower pace of rate hikes and inflation has clearly peaked. So with the market being myopic it is not surprising that we are in another bull market (Dow is up 20% from the 52w low). And I think this V-shaped recovery set up that followed the COVID shock and the 2022 inflation shock is lulling markets into a false sense of security. If there is a bad recession there won't be the same stimulus there was during COVID. And that means there is unlikely to be a V shaped recovery so the economy will probably stagnate for a few years and if corporate earnings fall 20-30% and stay depressed that will weigh heavily on sentiment and markets will be less inclined to look through to the pivot and recovery. As for what will make the recession bad I think it will be a combination of the following factors: -Delayed impact of the interest rate hikes -Continuing supply chain disruptions especially if COVID makes a comeback and only first world countries are adequately vaccinate and the Ukraine war likely to drag on into 2023 -Delayed adjustments to cost of living. People take a while to adjust their spending habits and cut back and most of the wage increases will go through in 2023 which will hurt margins and might prompt more job cuts. And people worrying about a recession results in more precautionary saving and less spending which creates a self fulfilling prophecy -Trade linkages. USA is well positioned but Europe definitely has a bad recession on the cards due to Ukraine war and energy crisis and China is still messing about with zero COVID policy and S&P 500 companies get half their sales from the ROW so even if the USA economy holds up corporate earnings may not. -Energy prices. Supply is still tight and while there will be some demand destruction in a recession you would expect OPEC to tighten and the strategic reserve releases cannot go on forever

The way I am seeing it we are still at 20x 2021 earnings of around $200 which most likely are peak earnings for this cycle and more artificial than peak earnings of other cycles because of the unprecedented fiscal and monetary stimulus and the outsized benefits of the pandemic to tech companies that dominate the S&P 500. Also these earnings were boosted by the ability of companies initially to pass on price increases while maintaining peak margins and buybacks have also been very supportive of earnings this cycle helped by low interest rates. 20x multiple has been pretty typical this century but in large part that is because bond yields have been very low and there is a real prospect that bond yields will have to normalize around 5% to keep inflation in check. That would seem to justify a multiple of more like 17-18x and even lower if bond yields need to go even higher. So you can question the multiple implicit in the current SPY valuation. And then you need to ask what normal earnings are likely to be. Market seems to be happy to look through any 2023 recession expecting a V shaped recovery similar to what transpired after the COVID shock. And assuming that once all this passes we will be on track for the $220-$230 EPS that was expected at the start of this year. That gives you a forward multiple of 17-18x which still seems quite rich for a moderate rather than a low interest rate environment. But what if earnings fall below $200 (which seems likely) and then do not fully recover so remain below $200 for a few years? And what if interest rates remain around 4-5% or so as central banks are wary about pivoting until inflation is below target?

2022 oil price gains now erased as markets start to worry about zero COVID policy in China with cases starting to rise. The adage is oil stocks are for trading not holding but I think supply tightness will still dominate so continuing to hold

Black Friday sales record breaking but a lot of people I have spoken to have taken advantage of the sales to do their Christmas shopping early and by definition Black Friday sales are lower margin than usual sales. And apparently lot of the sales done on a buy now pay later arrangement. Does seem like an eye of the storm type scenario where it seems that the worst has passed (inflation has peaked, bulk of the rate increases behind us, COVID in the rear window, US economy technically out of recession) but we are actually probably still halfway through the bear market with the story to shift in 2023 to falling earnings and how much damage will be done until the Fed is prepared to aggressively ease to bail out markets the way they always do eventually)

S+P 500 back above 4,000. Suggests renewed confidence in a soft landing. Inflation falling off allowing the Fed to pause and eventually pivot and no meaningful fall in corporate earnings.

Mike Wilson a Morgan Stanley strategist has a nice "fire and ice" metaphor. Even if markets are correct and inflation has peaked and the Fed is near the end of its rate hiking cycle a 2023 global recession and falling earnings could mean we still haven't seen the bottom.

Earnings are the second leg down. So if earnings can hold up pretty well over the next few quarters then markets will probably go sideways as rates continue to climb.

To me it seems a lazy argument that interest rates will stay low because everybody wants them to be. Of course cheap money is addictive and like any addiction there will be withdrawal symptoms and tantrums. The Fed clearly doesn't want them to be low anymore because it is now worried about inflation rather than deflation. There will be variations in interest rates depending on the cycle but the days of zero interest rates are probably over and people who arranged their affairs on the assumption that interest rates will stay low forever will have to adjust to the new reality and take their losses with good grace.

I think it goes to show that it is a news driven speculative market still. People are trading Fed announcements and earnings releases and not really focusing on long term fundamentals. This kind of behaviour makes me feel we aren't anywhere near a bottom.

The truth lies probably in the middle. Inflation is PARTLY transitory and we are most likely past the peak. It will probably drop down to mid single digits reasonably quickly as the economy slows down and supply chain issues ease and price level effects drop out of the index and companies find it increasingly harder to raise prices going forward. But the Fed will be unwilling to claim victory and risk easing until inflation expectations are anchored back to the inflation target (although would not surprise me if the inflation target was moved up to 3-4% within the next few years if inflation does prove stickier than expected). They've already told us that the plan was to frontload the rate increases so it shouldn't be long before we slow to a 50 bps pace of increase (which is not a pivot!) and a more cautious approach might also be justified if there are market stresses from bond market declines such as those experienced in the UK (I don't think the Fed really cares about what happens to the stock market so much) but so far in the USA at least there do not seem to be major issues. And I do not see a return to ZIRP or unlimited QE because the inflation genie is out of the bottle and the neutral rate is probably back around 3-4% and that new normal is going to have an impact on valuations especially for growth stocks and we are probably only partway through that valuation adjustment process as it takes time to adjust to a new reality And even if the economy does go into recession it will be difficult for the Fed to cut aggressively because it needs the recession to help bring inflation back towards target and all indications are that for the USA at least it will be a fairly mild recession so inflation will remain the main focus. And if it does so happen to be a severe recession then the fall in earnings will more than offset any benefits from the Fed pausing/pivoting in response. So I agree that either way you look at it we are probably only about halfway through the bear market and still have a little way further down to go before we bottom. At least for the index and the growth darlings in particular.

Yeah the Fed also said it would front load rate increases so just because it goes to 50bps doesn't mean that over the next year or so rates can go significantly higher. Also be careful what you wish for. If the Fed does pause or pivot then the benefit from lower rates will be offset by much lower earnings. The Fed started easing in 2001 and 2007 and the market didn't bottom until a year or two after that. And this time round with inflation uncomfortably high a lot more difficult for the Fed to aggressively slash to zero like it did in the last few bear markets.

The funny thing is that if you look historically (e.g. dot com bubble and GFC) bear markets generally bottom a year or two after the Fed STARTS easing. But this bear market rally seems in part to be triggered by belief that the Fed will follow the suit of other central banks e.g. Canada, Australia and start slowing the pace of rate increases and a pause or even a pivot is much closer. Maybe this time things are different because market participants are much more conditioned to respond to market liquidity rather than fundamentals and more willing than historically to look through recessions. But I suspect that earnings are going to determine the remainder of the bear market and while a recession will allow the Fed to take the foot off the gas it won't be able to ease to the same extent it did in previous recessions because of the stagflationary backdrop and that is a major negative for markets.

It is a bit of a re-run of the Nifty Fifty. Some of the FAANG stocks have been proven not to quite be as good businesses as everyone thought them to be. Others are still great businesses but mature and unlikely to grow anywhere near as fast as they did (especially during the pandemic which was a total bonanza for them) and rising interest rates is much more painful for them because they are priced as growth stocks. I'm a little leery with META. It is bad enough that social media is far more fickle and faddish than search with Tik Tok a formidable competitor they can't simply buy out like the other challengers. But then you also have all this futuristic metaverse crap. Netflix the programming isn't great and there is a lot more competition. Tesla is bound for a fall. It is the poster child of the pandemic bubble. Google looks solid with its moat still intact but of course advertising is cyclical and its mature Apple and Microsoft still look like cream of the crop. But of course fabulous businesses though they may be their high PE ratios make them vulnerable to sentiment i.e. the PE investors are prepared to pay for a great business. So PE compression is likely still a tailwind and they are mature businesses and Apple has already exploited the opportunity in services and Microsoft in cloud so those revenue streams are more mature and unlikely to allow for as fast growth going forward and even with great companies slowing growth gets punished harshly by markets. But yeah I think that how low markets go does depend to a large degree on what happens to the market leaders given that the market is still very concentrated with over 20% of the value of the S&P 500 represented by the tech giants.

Mostly reflects a narrowing trade deficit caused by strong dollar and consumers cutting back on imports. That is pretty low quality growth because exports will obviously suffer if the ROW goes deeper into recession or substitutes away from US goods and if consumers are cutting back on imports it won't be long before they start cutting back on services (which tend to be produced domestically).

I think the risk to the bear thesis (at least for now) is that Q3 earnings hold up better than expected. Most companies in the S&P 500 index have pricing power so at least for a while can pass on price increases which increases nominal earnings. Consumers for a while can stretch to bear the price increases especially with unemployment still low Some companies are benefiting from higher interest rates e.g. financials

Other point about bonds is you are getting 4% on Treasuries which compares to a 2% dividend yield on Treasuries. Usually you require a risk premium of 3%-5%. So you are requiring 6-8% earnings growth. You are also requiring no further PE multiple compression. Difficult to imagine 6-8% earnings growth when there are so many headwinds and financial engineering (big driver of EPS growth over this cycle has become a lot more expensive) and Big Tech (another big driver) are mature and have saturated their markets so will find it hard to grow much faster than world GDP growth (which is unlikely to be that impressive). Also difficult not to imagine further PE multiple compression when we currently still have above average multiples (17-18x) on peak earnings (beginning of the year forward S&P 500 earnings estimate of $230).

I also thought of TIPS as insurance against inflation but since inflation broke loose my TIP fund has lost half its value which is pretty messed up! Especially as the equivalent UK government bond fund without the inflation protection has lost only a quarter of its value. Must be something to do with the very long duration of inflation protected government bonds in the UK. Probably worth holding on to (or even rebalance) as might do well if the Fed eventually is forced to pivot but certainly aren't doing much for me as an inflation hedge! Re TINA yes bonds were in a bubble because central banks were inflating their prices by being completely price-insensitive buyers. They were over-owned because central banks had disproportionate stakes they are trying to unwind. Difficult to see how far this process will go and whether private buyers will be willing to replace central banks without requiring much higher yields. But if you believe that central banks can bring inflation back towards target and we will eventually return to a low inflation low growth world then a 2% real return is pretty attractive especially as getting inflation back to that level could involve a lot of pain for stocks and if you hold to maturity it doesn't matter what bond prices do in the interim and you can reinvest that 4% coupon at lower bond prices. I think in general markets seem reasonably sanguine about the impact of rising interest rates and quantitative tightening because of the implicit assumption that a pivot is coming. But it is quite clear that lower interest rates and QE have been a massive driver in supporting stock price increases over this cycle and now this process is in reverse there could be a lot more downside to come especially as we are only getting started with QT.

There were some mini-bubbles in "stay at home" plays and "save the world" plays. And the pandemic was favourable to technology companies so even the quality companies became overvalued (although nowhere near to the same extent as in 1999). But the real bubble which is finally bursting is in bonds. Also it is problematic that we are heading into a global recession and central banks are tightening and governments are tapped out after spending so much during the pandemic. That is not a very good macro set up and a corporate earnings recession will combine with further PE compression so I also find it difficult not to imagine markets going a lot lower. If anything the decline has been quite orderly after the initial shock when markets realized that the Fed meant business and inflation wasn't as transitory as everyone thought. I guess there is a bit of a tug of war. A large segment of the market figures the Fed will eventually pivot the way it always does as soon as inflation starts to moderate and jobs/GDP data gets worse and is happy to look through any resulting recession. Others are more bearish and think inflation is sticky and interest rates will have to go higher and stay higher for longer than most believe is possible and even if you look through the recession sustainable earnings are probably lower than those that were achieved during the heydays of cheap money, an earnings boon from the pandemic and inflation nowhere to be seen.

Interestingly if you look at 73/74 earnings didn't fall off a cliff falling only 20% or so but you still got a severe bear market because of the combination of lower earnings and lower multiples. Data points can give a useful base case. But need careful interpretation. If you look at the grand span of stock market history 50% drops seem rare. But in the 21st century they seem to happen every 10 years or so! Because in the 21st century the Fed helps to blow up bubbles and when they deflate they tend to take the overall stock market down by quite significant amounts. Not sure what is behind the stock market moves. But seems quite typical of a stock market struggling for direction and my best guess is that people are seeing that the market is back to 2020 levels and thinking it is overdone and a good opportunity to buy. But the bears still seem to be in control so I think we have further to grind down over the coming months.

Not sure how we can be considered close to an "epic bottom" when the S&P 500 is above 2019 levels and trading at around 17-18x earnings and is only down 25% or so from what was clearly a speculative peak. There is more fear in the markets that is for sure and a few canaries in the coalmine starting to sing. But I think a large segment of the market still believes we are close to the bottom and a pivot is coming and do not want to miss the turn. There is also still the "bad news is good news" mentality whereby bad economic data or signs of stress in the financial system increase the chances of a pivot or a bailout/resumption of QE so are seen as bullish which gives the Fed an omnipotence it really does not deserve. There is also the feeling that the Fed is pushing the global economy into recession so as soon as the Fed backs off all will be well. Also memories are short and markets haven't experienced a proper bear market in a long time. They are used to the quick crashes that end with a Fed bailout and a swift recovery to new highs. But so far this is playing out in textbook style with a long and prolonged grind downwards with impressive but brief bear market rallies and we probably have another 6-12 months to go before we finally bottom. We still haven't really seen the earnings story play out. Markets are still trading on inflation prints and Fed minutes/decisions. We are still in an earnings revision cycle and we've seen how markets punish disappointment and that process will continue until consensus estimates are more realistic. Also the S&P 500 is still 25% technology stocks and I think there is still a lot of vulnerability there as they are global companies that will suffer during a global recession and also there was a lot of technology investment during the pandemic that inflated earnings and that will stop as companies try to make cuts to weather a recession and they are also most vulnerable to further rises in interest rates. The technology giants are also now mature companies that have saturated their markets and are therefore more affected by the economy and will struggle to grow. Companies like Apple, Google, Microsoft used to trade for like 15x earnings when they had far far far more room to grow earnings and revenues. So in some ways it is a Nifty Fifty scenario and even for the good companies in that bunch the declines were far more brutal than the 30% or so decline the better FAANG companies have experienced.