mattee2264

I think an interesting question is what happens to market valuations once market participants get used to the idea that interest rates may have to stay higher for longer to keep inflation in check over the next decade. Agree that a lot of the COVID inflation was transitory. But there are operative factors such as trillion dollar deficits, de-globalisation, natural resource shortages etc that mean we probably aren't going back to ZIRP which has been massively supportive of valuations.

I'd say the bears got the following elements of their thesis wrong. Big Tech: people were expecting a re-run of the 2000 tech bubble bursting. But Big Tech have recovered all the 2022 losses because earnings have held up better than expected and there is future optimism about the course of interest rates/inflation and of course the hype about AI means investors can now project a lot more future growth. Another factor is that Big Tech is seen as defensive by a lot of investors especially given their outperformance during the COVID recession so rotating out of cyclicals and into Big Tech as recession fears start to build has also been supportive of stock prices. US Gov: deficit spending of over $1TR a year at full employment is very supportive of the economy. And it goes a long way towards offsetting the impact of tightening monetary policy. Rate sensitivity: while we have seen stuff breaking e.g. pensions in the UK, regional banks in the USA etc. the damage has been contained and the Fed has been able to mop up by injecting liquidity into the system and liquidity is very supportive of stock markets. Unemployment: we are still at close to full employment. That is supportive of consumption which is the lifeblood of the economy. Excess savings: this has helped cushion the blow of a higher cost of living and higher interest payments Sentiment: there is still a buy the dip mentality especially in the younger generation of investors for whom the GFC and dot com bubble are distant memories and in this long long bull market any losses were recovered very quickly (e.g. 2015, 2018, 2020, 2022) and there is still a belief that if things get bad the Fed will bail them out. But really it comes down to earnings and multiples. Bulls are foreseeing a mild earnings recession and their 2024/2025 estimates are well above $200. So with a 20x multiple (on the assumption interest rates have peaked and will moderate to around 2-3%) you get close to 5000 SPY. Bears are seeing a modest/severe earnings recession and see 2021 earnings of $220 as peak earnings and typically bear markets bottom out at around 14x peak earnings which gets you to 3000 SPY

Contrarian indicator?

Fiscal stimulus is ongoing with the debt deal just normalizing emergency level trillion dollar deficits despite the fact we are at full employment and the pandemic is long over. So that is definitely providing ongoing support to the economy. I think we have seen something akin to tacit collusion whereby companies en masse have been able to put through hefty prices increases without much resistance. Perhaps if we do go into recession some of these price increases will have to be reversed to some degree. And already we are starting to see a bit of that. I am not expecting a lot of wage inflation especially if we go into recession but there will be some because generally pay reviews are annual usually at the start of the year and in 2022 companies were probably able to get away with the pre-pandemic 3% pay rises but will probably need to give a bit more this year. What has been a bit surprising is the degree to which Big Tech have been able to maintain pandemic earnings (well in nominal terms at least). My assumption was that to some extent pandemic earnings were unsustainable as they were achieved when everyone was on their phones/online 24/7 and their old economy competitors were severely handicapped by lockdowns etc. But I guess it goes to show how strong Big Tech are and how people continue to underestimate them. But they haven't been properly tested by a recession so I think earnings could show a bit more cyclicality than people are expecting if we go into recession later this year or early next year. And I think to some degree their explosion in prices YTD is a replay of the COVID period when people saw them as a safe haven. In other words, they are the new defensives (forget bonds, consumer staples, utilities etc!). And what could be more seductive than a select group of stocks which offer glamour, incredible past performance, apparent safety (largely based on their pandemic performance), familiarity (especially for the younger generation), and seeming invincibility as every time they get knocked down (e.g. 2018, 2022) they come back stronger and reach new highs. And now the added kicker of an incredibly fertile avenue for future growth in AI. So little wonder everyone wants to own them and pretty much does and is comfortable paying high double digit multiples even as interest rates head higher.

AI is used as a partial justification for the Fantastic 7 melting up. But aside from Nvidia (where the revenue benefits are clearly already more than priced in!) is it really going to move the needle that much over the next decade? Companies like Google, Microsoft, Apple are already making around $200-$400BN revenues a year. Even if revenues from generative AI grow at a rapid clip similar to Cloud from a low base it would probably take many years to account for more than a fraction of their revenues. As for traditional AI it is really nothing new and these companies already have sophisticated data analytics capabilities that are already contributing strongly to their huge revenues so while it might improve the value proposition for someone like Microsoft especially for upgrades etc and perhaps allow companies like Google and Facebook to target their advertising even more effectively will it generate tens of billions of new revenues for them? And generative AI feels a bit gimmicky at the moment e.g. Bing has a new AI co-pilot etc but it has made no difference to me and I still use Google and most of my friends are asking Chat GPT silly questions and laughing at the answers and more techy people are delighting in finding ways to trip it up. And you also have to wonder to what extent it will start to cannibalize their existing main revenue streams which are already starting to look very mature and will be difficult to maintain especially in a weak economy where the vast majority of their customers are struggling. Also there seems to be an assumption that mega-caps will be the main beneficiaries when history would generally suggest that while they clearly have a massive advantage in terms of making investments, buying up promising start-ups, hiring the best talent etc. so did IBM and Microsoft back in the day (before Microsoft rediscovered its mojo) and Google and Meta emerged AFTER the tech bust. So often with a new technology it favours more innovative entrepreneurial companies that don't have to worry about their existing businesses being cannibalized and have a fresh perspective. Even if there is an incredible long term opportunity in the near term non-AI revenues are clearly going to come under challenge especially if we are heading for a hard landing. Apple, Facebook, Google and Amazon all have cyclical revenues. Tesla is an automobile company and autos are famously cyclical. And even in a soft landing that the Fed are predicting whereby GDP growth is only 1% or so for the year that will translate into single digit growth figures which rarely goes down well when investors are paying 30-60x earnings expecting double digit revenue and earnings growth as far as the eye can see.

I think what the post WW2 history shows is that bull markets can be very long and stocks can therefore remain expensive for long periods of time. Even if eventually there is a bear market which brings stocks closer to or below fair value the problem is that fair value increases over time in line with earnings and dividend growth as well as inflation so staying out of expensive markets hoping you can buy back lower when valuations are more reasonable is generally a losing strategy. But difficult not to feel a little bit anxious when the S&P 500 is fast approaching the 2021 high which was generally regarded as a speculative peak produced by a) Unprecedented monetary and fiscal stimulus b) zero interest rates c) post-COVID growth optimism. The only factor still operative is expansionary fiscal policy which I think has been keeping the economy afloat.

Monetary policy operates with a long and variable lag (usually estimated at around 2 years) and we only started hiking at the beginning of 2022. While we are still receiving the benefit of $1TR fiscal deficits so it is not surprising that fiscal policy is dominating monetary policy and the economy is still holding up. But the degree of GLOBAL monetary tightening is significant and when its full effects are felt there is certainly a risk that it will push the global economy into recession which will result in an accompanying fall in corporate earnings which is a negative for markets. The bulls may eventually get the pivot they are hoping for but it will only happen when there is a hard landing at which point the benefit from lower interest rates will be overwhelmed by falling earnings. And this happens in every recessionary bear market. It begins with the Fed tightening and then the Fed pivots and some time afterwards the market bottoms and then shortly after that the economy starts to recover. Of course it is never be by design and it is notable that the Fed's projections assume a soft landing. They are political so do not want to be seen as knowingly pushing the economy into recession. But I am sure privately they know the risk is there and feel the risk is necessary to regain credibility.

Their "two more rate hikes for the year" forward guidance assumes no recession (their 2023 GDP estimate is 1.1% revised upwards from 0.3% in March). So Powell is definitely expecting a "soft landing" scenario and all his forward guidance has to be interpreted on that basis.

Some interesting comments from Powell's presser. Of course he is data dependent so if inflation falls off a cliff and we fall into recession this may all change. But certainly indicates rates will stay higher for longer. I wonder that once markets start to believe this they might assign lower PE multiples to stocks. “It will be appropriate to cut rates at such time as inflation is coming down really significantly. And we’re talking about a couple of years out.“ "I think, as anyone can see, not a single person on the committee wrote down a rate cut this year -- nor do I think it is at all likely to be appropriate if you think about it." "Inflation has not really moved down. It has not reacted much to our existing rate hikes. We’re going to have to keep at it.” "There's just not a lot of progress in core inflation." "We want to see it moving down decisively." "Risks for inflation are still to the upside."

Agree re the quality. But given the size they are now are growth prospects over the next 5, 10, 20 years that great? And is it reasonable to pay at the low end 30-40x earnings and at the high end 60-70x earnings when interest rates are 5%. Companies are usually judged to be great businesses with the benefit of hindsight and there is no question that they've eaten the world over the last decade and done amazingly well. And a lot of Nifty Fifty businesses remained great businesses but their stock price performance disappointed due to multiple compression and earnings growth that was impressive but reflected their maturity. I would say though they have a lot more durability and resilience than the tech companies of the 90s and consumers and businesses cannot function without them which should still make them very valuable even if they cannot maintain double digit growth rates going forward.

What does give some pause for thought is it would be highly unusual for the leaders in the last bull market are to be the leaders in the next one. So the fact that the Big 7 have accounted for roughly 70-80% of the YTD gains is a little worrying especially as the rest of the index has languished. On the other hand the rally in the Big 7 has gone on too long and too far to be dismissed as a bear market rally. And the operative factors that killed Big Tech last year (runaway inflation, earnings disappointments) seem to have faded away. So it seems more likely that we are still in the long secular bull market that began in 2009 with another innings thanks to the AI mania reigniting enthusiasm for Big Tech (and possibly eventually leading to a blow off top within the next year or two). Last year's bear market seemed more consistent with 1987/2020 in other words a shock driven market panic that was swiftly followed by a V shaped recovery and return to new highs and the bull market resumes its progress to new highs.

We talk a lot about the economy and clearly so far we've avoided recession and inflation is now fairly modest and we are still at full employment which is all bullish (for now). But the big driver YTD has of course been the "AI" 7 (AAPL, META, MSFT, NVDA, TSLA, GOOGL, AMZN) which is up approximately 80% YTD while the rest of the S&P 500 has gone nowhere. And if you look at the NYSE FANG+ index which adds to that list Netflix, AMD and Snowflake it is up approximately 70% YTD and is back at 2021 highs which were the product of ZIRP/unlimited QE and fast revenue growth during COVID as they were all major beneficiaries from people spending more time online and on their phones and businesses having to pull forward IT investment to enable remote working. Obviously a lot of buzz about AI and it might reinvigorate growth that was flatlining as their core businesses matured. But can it justify multiples which are 30-40x at the low end and 60-80x at the high end compared to 5% interest rates?

Agree that there is something conditioned about a) The flight to safety into Big Tech (given how well it weathered the pandemic) b) Excitement over the potential for a pause with inflation moderating (another Fed bailout) But of course conditions are a little different now. This isn't the pandemic so Big Tech won't get that same temporary earnings boost and while AI is exciting aside from perhaps Microsoft/Nvidia it won't have a material impact on profits which for most Big Tech companies have been treading water over the last few years. While if we do head into recession Big Tech are such a large part of the economy their earnings are sure to suffer. And any pause will be because the Fed can see clear evidence that the economy is weakening (which is probably driving some of the fall in inflation that markets are cheering about) and in most bear markets the bottom tends to be about a year after the first interest rate cut so careful what you wish for

Kuppy has a good point. Most of the damage will be in interest rate sensitive areas. For the rest of the economy the Debt Deal has basically normalized emergency level over $1TR deficits which is highly stimulative to the economy and to inflation. And the question is how far will the Fed go to try and offset expansionary fiscal policy and what will break in the process. But I think we have seen that even with falling private demand since COVID government spending has formed a huge portion of GDP and will continue to do so and that makes it a lot harder for GDP to decline significantly irrespective of any weakness in private demand brought about by rising interest rates. And then of course you have Big Tech that for the most part are highly cash generative so relatively unaffected by interest rate rises and even earn more interest income (and of course markets being markets then give that extra interest income a high multiple!) and the AI buzz which allows investors to dream about fertile future growth avenues even as their core businesses are pretty much ex growth. How all this all balances out for the market index is anyone's guess. But I imagine winners and losers and probably a sideways market until there is a bit more synchronisation once the economy starts to recover and interest rates are able to normalize

It is starting to rhyme a little of summer 2020. Big Tech is melting up because a) Excitement about new technologies (back then cloud, now it is AI) b) It is seen as a safe haven compared to cyclicals more exposed to the economy Also I am not convinced we are in a new cycle. Last year's bear market was mostly due to an inflation shock which hammered long duration assets such as bonds and big Tech. Once inflation started declining it set the stage for a V shaped recovery (in big Tech at least). And when it is so narrow based I do not know whether you can call it a new bull market. Narrowing leadership is very consistent with the final stages of a long bull market. Early stages of a new bull market generally have much wider participation and have legs because they usually coincide with a new economic cycle. Usually economic cycles are more or less synchronized with market cycles with market cycles slightly ahead due to their forward looking nature. So cyclicals are already pricing in some kind of recession later this year. And recessions usually last a year or so. So a recovery that sets the stage for a broad based bull market probably won't begin until the second half of this decade. As for what happens over the next year or two. I think it depends on a variety of interrelated factors: a) Whether we have a hard or soft landing and the timing thereof. b) How well Big Tech do in hyping up AI growth opportunities and whether that can support or even elevate valuations that look quite rich compared to interest rates c) How much liquidity gets drained out of the economy by QT (or whether there will continue to be stealth QE under the guise of supporting the banking sector and government deficits) d) How serious central banks are about getting inflation back to trend and whether they feel the relative insensitivity of the economy and markets to rate increases gives them room to go another 100-200bps higher before reaching the terminal rate e) How all of the above affect market sentiment which at the moment seems pretty sanguine when you consider how many uncertainties there are at the moment

Yeah while there's been another V shaped recovery in stock prices extending the secular bull market even longer it probably comes at the cost of much lower prospective real returns over the next decade. At least for index buyers. But if you avoid Big Tech and pick your spots you can probably do a whole lot better. EAFE for example is trading at 13x forward earnings compared to 18x forward earnings for the US stock market and EM is trading at 12x forward earnings. And if there is some kind of AI productivity growth miracle those markets would probably do very well over the next 10-20 years.

I am more inclined to think the market will continue to be range bound/trade sideways as momentum in technology stocks offsets any further weakness in cyclicals. And probably by the time the tech rally runs out of steam and there is a correction there will be grass shoots in the economy and a rotation into cyclicals will keep the market afloat. It does seem almost certain that 3500 last year was the bottom for this cycle.

A friend shared a crazy chart with me. From end of last year Big Tech (META,AMZN,AAPL,MSFT,GOOGL,TSLA,NVDA) are up 53%, S&P 500 is up 11% and the remaining 493 companies are essentially flat over the last six months or so.

My basic reasoning is that a) The tech bear market was last year driven a hawkish Fed and the inevitable disappointment in results compared to the bonanza revenues and earnings achieved during the pandemic b) Even if the economy goes into recession this will further encourage a rotation into tech which given the current index composition is neutral to bullish for the market level. Reason for the rotation is a) tech is seen as less economically sensitive b) a recession could mean a pause/pivot which means lower discount rates which is good for long duration growth stocks c) AI means more growth options and cloud is likely still in relatively early innings at all. So this should ease concerns that Big Tech are becoming mature and therefore their days as growth stocks are behind them d) The quick reversal of the large losses last year increases confidence that any dips are buying opportunities and Big Tech are unstoppable Personally I do find 30-40x earnings a bit rich for my blood for trillion dollar market cap companies that by law of large numbers and basic economics will struggle to grow at double digit rates going forward. Especially as interest rates are 5% and higher. But the lesson from this bull market has been that you can't go wrong owning Big Tech and it seems more likely to me they will go sideways over the next decade but not necessarily fall off a cliff the way the Nifty Fifty bull market and dot com bubble ended and therefore I think the market will probably follow suit and go sideways with modest volatility for the foreseeable future unless of course AI goes from being a mini bubble to a massive bubble

What's incredible is that Microsoft and Apple together account for almost 15% of the S&P 500 by market cap and adding the other Big Tech companies you easily get above 25%. Any rebalancing of the index driven by the 2022 bear market that fell most heavily on Big Tech names has gone into reverse and we are more concentrated than ever. And most of the Big Tech names are back trading close to or even above the end of 2021 highs even though interest rates are over 400 bps higher with an average multiple of around 30-40x earnings. It reminds me a little bit of the tech melt up during the COVID recession with tech viewed as a safe haven. In any case it is hard to make a case for the market revisiting last year's lows unless Big Tech takes another big tumble.

Depends on what age you are. In the first half of your life I think an annual income figure makes more sense. And in a big city you probably need at least a couple hundred thousand a year to live like rich people with all the trappings such as kids in private education, big house in a desirable area, luxury holidays, eating out regularly at the best restaurants and so on. If we are talking in terms of a net worth figure then it is more relevant to the second half of your life and really I think a few million is more than enough to present as rich as your kids have probably left the nest and your house is probably paid off and you're probably able to downsize or more somewhere cheaper given you don't have the need or even the desire to live in a big city for your work

It is a strange dynamic. In a market dominated by growth stocks recession is pretty bullish as it means lower interest rates and it also helps that AI helps investors project dazzling future growth rates which helps them overlook that recent earnings have been pretty disappointing. The old economy stocks (financials, retail, commodities, housing etc) are selling off in anticipation of a recession and are down 30% or more from the highs. But they aren't important enough to make a massive difference. Even during COVID when they were still at multi-year and in some cases multi-decade lows the market was back above 3000 by the summer simply because investors had crowded into technology stocks. And it seems a similar dynamic. Instead of embracing 5% bonds as safe havens investors are loading up on Big Tech priced at 30-40x earnings.

OK so there won't be any internal or external discipline to prevent the US Government from continuing to run annual deficits of over $1TR. That being said surely this means the balance of risks is skewed way more towards inflation than recession given we already saw during COVID how government spending can counter the economic cycle. Of course this time round it will be partly offset by the impact of higher interest rates but so far they've seemed to be pretty impotent having little impact on jobs or the stock market for that matter. Yes there were fiscal deficits before COVID and during the GFC but during the GFC the fiscal stimulus was much smaller and post COVID with the Democrats taking over the fiscal stimuluses are more socialist in nature whereas the Republican stimulus was more targeted to the rich eg tax cuts.

With the debt ceiling deal done Democrats will be able to continue trillions of annual deficit spending which will put them at odds with a Fed that wants to reduce inflation. Obviously Republicans are toothless and just looking to score points with trivial spending cuts. And for some reason global markets aren't willing to impose any discipline. I remember the utter outrage at the fiscal plans of Liz Truss in the UK and the market reaction with the pound plummeting and interest rates spiking across the board. But somehow it is OK for the USA to run trillion dollar deficits and no one blinks an eye. But with that kind of ongoing fiscal stimulus it is difficult to imagine a deep recession and inflation is more likely to be an issue going forward

Most utilities are natural monopolies. That gives their cash flows a predictability and stability which means that even with low growth investors are prepared to pay high multiples. I think with Big Tech a similar dynamic applies although obviously they aren't encumbered by regulation and can absorb the occasional anti-trust fine which is as far as competition authorities seem willing to go and have some growth options and much lower capital requirements etc. So I do understand why multiples are high and everyone owns them. But the nature of markets is that there is always some sound reasoning that can get taken too far and the high multiples do create some vulnerability given that several years ago when they had way more growth ahead of them and their earning power was far more understated by GAAP and interest rates were much lower they were valued at only 20x earnings. And equally when they dominate the market indices to the extent they do it is difficult to make much of a bear case without foreseeing a large fall in their stock prices.