mattee2264

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.

For me the pennies that still have to drop are: Consumer staples...OK they are defensive but they are still trading as bond proxies and have 20+ PE multiples and sub 3% dividend yields and margins are vulnerable and with a reliance on overseas markets for growth there is vulnerability there FAANGs.....OK the quality ones have lost 1/3 of their value and the tarnished ones have lost 2/3 of their value but after eating the world and gaining a lot of market share during the pandemic it is hard to imagine that their earnings won't fall if the global economy goes into recession because they are such a huge part of the global economy and if that happens they will get severely punished. Financials....these generally are not something you want going into a recession and while a recession has been partly priced in if it does turn out to be a bad one and there are threats to financial stability from bond bubbles bursting etc like there were in the UK then things could get messy.

If you look at the history stocks become a good inflation hedge AFTER PE ratios have adjusted . We are part way through that process. At the same time you are capitalizing peak margins and peak earnings and during the adjustment process margins will take a bit of a hit and earnings are no longer getting the boost from unlimited stimulus and cheap money so again a bit of adjustment to go. In high inflation environments such as the 70s PE multiples averaged around 10. In low inflation environments such post 2000 PE multiples averaged around 20. We are probably headed for a moderate inflation environment because there are some secular inflationary forces (e.g. labour shortages, de-globalization, resource scarcity etc) and the Fed cannot be as tough as it wants without threatening financial stability. So I think a 15 multiple is probably about right. Inflation was pretty high post WW2 but because the starting point was low PE multiples stocks did incredibly well especially as inflation started to moderate. Inflation was high in the 70s but because the starting point was high PE multiples stocks did badly and you'd have fared better just rolling over Treasury bills. As for where we are now inflation is high but is already moderating. PE multiples are high but I do not see them falling as much as they did in the 70s. My personal take is that at current market levels you will get some kind of real return over the next 10-15 years but it will be well below the historical average of 7%.

I think an era of cheap money has resulted in a lot of distortions. Since the GFC growth has been anaemic. So low interest rates have done very little to stimulate growth but a whole lot to stimulate asset prices. Instead of encouraging productive investment most companies have found it more profitable to engage in financial engineering borrowing to fund buybacks. And by encouraging speculation we've had a bubble in technology stocks and an associated M&A craze. Cheap money has also encouraged silly economic theories like MMT which make governments think they have no need to fund massive fiscal packages because central banks will always be there to keep government debt cheap and buy up most of it. But now everyone is worried that high interest rates will plunge us into a deep recession and are complaining about falling asset prices and the evaporation of all the speculative gains they've made during the pandemic. A recession is a price worth paying to re-establish Fed credibility and anchor inflation expectations closer to the 2% target and cool demand until the supply side normalizes and can handle higher demand. Government policy needs to focus on easing immigration and slowing down the pace of the energy transition and those steps will allow lower interest rates in the future. But of course it is much easier for governments to blame the Fed both for causing inflation and then the subsequent recession. And a more reasonable level of interest rates will establish a more appropriate cost of capital and encourage more productive investment. And if it results in some zombie companies going under and companies getting rid of unproductive staff then that is a good thing and those resources can be reallocated more productively.

Quite a lot of speculation about a 2M a day OPEC output cut. Looks like the market made the same mistake of pricing in a recession and forgetting that the inevitability of a global recession strengthens OPEC's desire to cooperate and agree large output cuts. Saw this playbook in autumn 2020 when everyone realized the winter wave of COVID was going to be very bad.

I think the overall market mentality is still very speculative. You can already see the BOE pivot to QE and the smaller than expected RBA rate rise and the UN calling out the Fed are fuelling hopes that the impetus for tightening is starting to diminish and central banks will start worrying about financial stability and take their foot off the gas. We are on course for the best 2 day rally on the S&P 500 in 2 years. We already had a summer bear market rally of 17% and my guess is there will be another one in the winter when the pace of tightening starts to ease off. But markets are still giving the Fed an omniscience that is undeserved. Whether we have a hard landing or a soft landing has little to do with the Fed and if we do have a hard landing and earnings crater then the Fed may be able to pause but it will have little room to pivot with inflation still well above target and it will not want to risk losing what credibility it has regained in this hiking cycle until it is clear that demand destruction is bringing inflation down significantly. The other thing worth noticing is that OPEC cooperation appears alive and well with talk of a 2M barrel a day cut which will push up inflationary pressures and hurt margins. That is not at all bullish!

I'm also trying to decide how to play it. I think the fundamentals are very good. OK there is a global recession underway but demand for oil is pretty inelastic and OPEC know the world is in recession which will make output cuts easy to agree and supply is very tight. Energy companies are also flush with cash and using it to buy back stock and pay dividends etc. Obviously traders can push the oil price well above (e.g. earlier this year) and well below (e.g. COVID lows) a reasonable value. But I think that at least for the foreseeable future oil prices can average above $80 and that makes energy stocks look very cheap unless you are expecting a very fast energy transition/punitive regulation and legislation etc.