mattee2264

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.

UK I am also thinking $200 or so as a kind of ball park estimate for normalized earnings for the SPY. Essentially splitting the difference between pre-pandemic earnings of $160 and the 2022 estimate of $240 which obviously did not anticipate the Ukraine war or the hangover from all the fiscal stimulus wearing off. I get it at another way by thinking that pre-pandemic we were in a low growth low inflation environment with limited cyclicality so no real need to normalize but it is reasonable to add a bit to reflect intervening inflation and some degree of earning boost from structural changes resulting from the pandemic. Agree with you that 15 seems a more reasonable multiple than the post-2000 average of around 20 given the higher interest rate/inflation rate environment. Of course the SPY tends to go below fair value in a bear market and aggressive rate hikes when we are already in recession would seem to encourage an overshoot. But I think that the risk of a pivot means it does not pay to get too greedy and historically if you can buy a 40% discount to the peak (even speculative peaks such as 2000 and 2021) you haven't regretted it.

I think the problem is the market made its usual mistake of capitalizing peak revenues and peak margins at generous multiples as well as extrapolating very fast recent growth rates (that in many cases were the result of pandemic conditions and the fiscal bonanza). Pricing in more realistic estimates of earnings and growth rates is going to be a painful adjustment process.

Earnings season could be pretty brutal. Nike already warning on a hit to margins as a result of a strong dollar and excess inventories. That follows on from Fed Ex earlier this month. It will be a death by cuts as each blue chip (and smaller peers) are taken out and shot as markets realize estimates were overly rosy. And of course if there are enough negative earnings surprises or disappointing guidance then investors will want to get out before results and that will accelerate the pace of declines. We ended 2021 with SPY earnings estimates of around $230 for 2022 and $250 for 2023 and bond yields of 1.5%. Peak SPY was around 4800 so that was about a 20x multiple on 2023 earnings. We will probably close the year with bond yields of 4.5% and 2023 SPY earnings estimates will probably fall below $200. We are at 3600 at the moment so that is around a 15x multiple on 2023 earnings (as originally estimated) which seems appropriate given the change in bond yields. But if 2023 earnings fall below $200 and there is no immediate prospect of recovery (seems likely given there will be a hit to margins as well as to demand) difficult not to see the SPY falling below 3000.

My understanding is that there was an issue for insurers/pension funds to do with collateral when bond yields spiked (and bond prices crashed). Obviously bond yields spiked because there is now a massive risk premium involved in holding UK government bonds because the market has lost confidence in its ability to repay. And we are talking about a move from sub 4% to over 7%. If there is some contagion there might be some loss of confidence in other countries government debt and an associated risk premium being priced in. US should be relatively insulated and even benefit as there is a flight to the safety of US government bonds but contagion is a funny thing and not always rational. But I think it is quite inevitable that there will be some form of yield curve control which I think is essentially what the BoE is doing by using QE to buy long bonds. I think that a combination of increasing interest rates while doing a bit of QE to facilitate orderly market adjustments should still allow gradual tightening and suppression of inflation. And of course it is bullish for markets because it means central banks are going to be a bit less aggressive going forward.

Hard to see the USD strength fading. The US is less affected by the Ukraine war, its economy is in better shape generally, it is seen as a safe haven, and it might be able to increase energy exports. But it does help to bring down inflation and I suspect that the Fed will be the first to pause/pivot and that will cause the dollar to weaken probably sometime next year. I think the Fed is concerned about credibility so it will tighten more and for longer than it would otherwise have to. Asset prices will continue to be collateral damage. But really all that has happened so far is we have given up the 2021 gains and worst case scenario we may give up some of the 2019 gains but is that such a big deal in the context of such a long and impressive bull market especially if it means that valuations are reasonable again and housing is more affordable?

Anyone have any thoughts on exchange rates? I'm a UK investor so a lot of the benefit of cheaper global stock prices has been dilutes by a decline in the purchasing power of the £. In part due to internal UK issues but the dollar strength has been a major factor. The dollar is at multi-decade highs against other major world currencies. In part it seems understandable -US economy looks the strongest and it doesn't have the same energy crisis Europe faces this winter and might even be able to take advantage and up its energy exports -Fed is more aggressive than other central banks so relative interest rates are higher than other major economies -USD has a safe haven function with all the turmoil in the world -Alternative currencies look unappealing But the US economy won't be immune if the global economy goes into recession and also has fiscal deficits and current account deficits that tend to put downward pressure on currencies over time and the strong dollar should help moderate inflation which might allow the Fed to be less aggressive in the future while making inflation worse in other countries forcing their central banks to be more aggressive with rate hikes.

If interest rates head up to 4-5% and SPY earnings come in a lot lower than the estimates of $230 then you'd think the SPY would end up closer to 3000 than 4000. Inflation probably will moderate as the stimulus wears off and interest rate hikes start to feed through to the real economy and supply chain issues continue to ease. I also think there will be some eventual resistance to price and wage increases as companies and workers have been quite opportunistic since the pandemic. But inflation moderating increases the attractiveness of bonds as an alternative to stocks. Also inflation moderating means more of the burden adjustment will fall on the nominal price of the SPY. In nominal terms we have seen around a 15% decline. In real terms that has been more like 20-30%. With double digit inflation markets can go sideways while still correcting to a reasonable level in real terms. That is a lot harder to achieve with lower inflation. Especially if the source of lower inflation is lower demand and therefore earnings. I am also more convinced that the end game will be a bust with the Fed's hands tied because it is determined to keep a lid on inflation expectations and will only be happy to ease once inflation is well under control and there is clear evidence we are in a recession and no longer at full employment providing the justification it needs to pivot.

3-4% is based on the historical record. These days 60/40 would not work because real bond yields are deeply negative. So you would want a higher equity percentage with 80/20 quite popular these days and then you have a much higher sequence of return risk. So I think there is a lot to be said for having a bit of flexibility. For example having a part time gig that you can ramp up in a bad year for markets so you don't have to sell in weak markets. Also good idea to own your own property so that your living costs will be lower (i.e. no rent) and also less inflation risk (no rising rents).

Agree with you. On the other hand markets were 100% correct about the V shaped recovery from COVID while most economists and even Buffett were expecting a depression. But 2021 earnings were super juiced by extraordinary fiscal and monetary policy which went well above what was required so a bad hangover does seem like it could be a possibility. But I think with the Fed supportive markets will probably look through any recession and let the economy work through the "transition"

Yeah 50+25+25 is more my reading. Powell said he wanted to front load the rate hikes and in the latest meeting was talking about more gradual increases going forward. He has admitted monetary policy operates with a lag which encourages a wait and see approach. I think 2023 will be far more about earnings than rates. If S&P 500 goes into an earnings recession and 2021 earnings prove to be unsustainably high then you'd expect a negative market impact. And the Fed is not really leaving itself a lot of room to cut rates when inflation has some way to go before it returns to target and remains a political issue. So pause is probably more realistic than a pivot. But yeah I think it was a little naive to think the Fed would end the bull market. The market had its usual panic before realizing that the Fed is still pretty dovish. Usually deep recessions end long bull markets but I do not think one is on the cards and bad news is good news because if things get bad enough the Fed can start easing and printing and we have seen how effective that was during the Great Flood equivalent of the pandemic! So a garden variety recession should not really trouble markets. So I kinda feel this will have the usual ending. Eventually markets will take on a bit too much risk buoyed by optimism and total lack of moral hazard and we will get some kind of financial crisis but probably years down the line.

I don't think there is any serious intention to engineer negative wealth effects by sinking stock markets. Powell is very careful with the open mouth communications to provide enough breadcrumbs to sustain hope and encourage markets to look through the rate hiking cycle. Next phase will be to focus on the trajectory rather than the level i.e. inflation is moderating and falling so I am gonna wait and see. Then it will be well we have an average inflation targeting regime now so a few years of 3-4% inflation isn't really a big deal. I think the only real way we can get a really serious bear market is if we have a proper financial crisis. Because recessions are good news because they mean lower rates (good for the long duration stocks that dominate the indices) and booms are good news because they mean higher earnings (which are then capitalized at high multiples) and cash continues to be trash.

Read some interesting data that suggest that the time to bottom depends very much on the depth of the bear market (which makes sense). If this is going to be a run of the mill 20-25% bear market then 1/2 a year is pretty typical and furthermore a swift recovery by the year end to all time highs is also the base case and bottom is already in. If it is going to be a deeper 30-40% bear market then bottom unlikely to be reached until 2023.

Seems as though the assumptions are that: a) Any "recession" will be mild and shallow b) Fed is almost done with the hiking cycle and will slow the pace of hikes and stop out around 3-3.5% and may even then drop back to neutral once it is considered that inflation is under control c) Inflation for the most part will fall to a more acceptable level of its own accord over the next year d) S&P 500 earnings will be much the same or even higher than 2021 e) Nothing will break as the Fed finishes off its tightening cycle Seems quite rosy but in this long long cycle a ~20% drop followed by a fairly rapid recovery once market nerves are soothed is quite typical e.g. European debt crisis 2011-2012, mild slowdown led by commodity price crash 2015-2016 trade war/slowdown/Fed tightening end of 2018 and now a Fed tightening/inflation scare which markets are now seeing as mostly a mirage.

Agree for the most part re 2018-2019. But I think the earning power of the S&P 500 probably is quite a bit higher in part because of inflation (and most companies have enough pricing power to pass most of it on increasing earning power in nominal terms) but also because of the tech dominance and the pandemic has meant increased adoption of e-commerce and cloud computing and that will be somewhat sticky. And of course share counts are lower as a lot of the temporary profit surges during the pandemic were used towards reducing share counts increasing EPS. I think the other question is whether it is still appropriate to use 20+ PE multiples that are sustainable in a low interest rate low inflation environment or whether we will revert to the 15 historical average.

Other point is that the job market is strong and we are near to full employment and ALREADY in a technical recession. So imagine what would happen if companies did start laying off workers en masse. Maybe what is really transitory is the "strong economy" which was mostly a product of irresponsible fiscal spending and money printing. And that is what markets are basing earnings estimates off.

I think a lot of companies have been quite opportunistic with price hikes and getting away with it for now and preserving their margins as a result. But eventually volumes will suffer which will require lower prices and lower margins which leads to lower earnings and that is probably going to drive the next leg down in markets. Especially once the rate increases feed through (monetary policy operates with a lag) and the self-reinforcing responses to slowing demand kick in (job layoffs and reduced investment spend) and so on. But of course right now markets are looking through to inflation moderating and the Fed easing off on rate hikes but still assuming any recession will be mild. They could well be right-they did a better job than economists at predicting the V shaped recovery from the pandemic-but if they aren't then lower earnings could be a significant tailwind.

Tourism helping and also probably a lot of pent up demand as Europe was quite slow with the vaccine roll-out and quite cautious in terms of lifting restrictions. But of course GDP growth adding fuel to inflationary fires so not all good and probably means that central banks will be emboldened to be a bit more aggressive with tightening.

My take is that by neutral they are meaning only in relation to the demand side. In other words they are trying not to add fuel to the fire but aren't willing to crush the economy to reduce inflation preferring to blame the war/supply chain issues etc. Pretty typical of central bankers to accommodate supply side inflationary factors. But not really helpful because once inflation gets built into expectations the underlying cause doesn't matter.

Oh and back in 2018 Powell said at 2-2.25% that we were a long way from neutral when inflation was only 2.5%. Now apparently we are close to neutral at 2.25-3% with inflation at 9%. https://www.wsj.com/articles/investors-love-jerome-powell-federal-reserve-markets-inflation-monetary-tightening-11658959032 So really it is just a repeat of 2018 when he was all about getting back to neutral and unwinding QE and then pivoted. Powell put is alive and well!