mattee2264

Powell has already given himself an out by saying he will continue hiking until there is convincing evidence that inflation is falling back towards trend. So all he needs to give himself licence to pause is for some evidence that inflation has peaked and is falling which should happen later this year as the economy continues to slow and supply chain pressures ease.

Yeah I think that currently everything is pointing to a soft landing. Q2 earnings releases so far much better than expected. Q2 GDP only mildly negative. Fed easing off on rate increases so clearly no desire to break markets. And the economy slowing without rates having to get to the point where they create systemic risk is good because it means inflation will probably moderate naturally without the Fed having to do too much. Of course lots of economists out there saying a hard landing is unavoidable and inflation will be sticky and persistent and won't go away without much more aggressive Fed action. But the same economists didn't believe a V shaped recovery from the pandemic was possible and were proved wrong. Also the elephant in the room. For all the talk about QT the Fed's balance sheet has hardly shrunk. And QT was supposed to contribute to the tightening required to tame inflation. Seems as though Fed will soon start talking about inflation heading in the right direction and use it to justify a pause and wait and see approach going forward. Of course monetary policy works with a lag so will take some time to see the frontloaded rate hikes impact on the economy What might well happen is that the real recession won't be until next year and the market is prematurely celebrating a soft landing

Grantham has some really good metaphors to try to navigate the end of this cycle. The confidence termite thesis played out as expected with the more speculative stuff getting killed in 2021 and now this year most of the majors seeing 30%+ declines. The other metaphor he uses is the two legs. First leg interest rates/multiples. Second leg earnings. First leg I think has now played out. Fed is signalling the end of the rate hiking cycle. Probably by the end of this year once we see a weakening of the jobs market. And the rally over the last month or so is probably because the market thought the Fed would be a lot more aggressive. Second leg earnings we've had a few profit warnings and a few earnings disappointments but S&P 500 earnings estimates are still around $230. Difficult to really see where a deep earnings recession is coming from. But I think 2021 earnings were juiced by monetary and fiscal stimulus and pent-up demand and companies bringing forward tech related spending to navigate the pandemic and consumers spending a lot more on e-commerce and consumer goods instead of services and the S&P 500 obviously is pretty tech heavy. One narrative is that inflation causes a recession. But I do not really buy this. We've had $100 oil before for multiple years and the economy continued growing. Core inflation is only in the single digits and as it is accompanied by some wages growth consumers are handling it and companies are passing on most of it. Similarly interest rates causing a recession....well we look as though we will stop around 3%. There is a lot of debt in the economy but a lot of it is fixed and locked in at very low interest rates. Somewhat higher financing costs will have a modestly negative impact on profits and probably a much greater impact on the housing market. But people have plenty of equity in their homes and really we would probably end up unwinding the speculative gains made during the pandemic. In fact pretty much everything that has happened so far can be understood as unwinding of the pandemic distortions. We were at 3300 or so before the pandemic. That was a few years ago and there has been some increase in earnings power especially from some of the societal changes that will remain after the pandemic (increased reliance on technology etc and consolidation of market power and also of course inflation). So I think adding around 10-20% for these factors and perhaps subtracting a little to reflect that interest rates will settle somewhat higher than they were pre-pandemic and it is difficult to see markets going much lower than they were earlier this year.

Well S&P 500 above 4000 again presumably based on belief that a soft landing is very much on the cards and the Fed will slow down the pace of rate hikes.

Problem with this is that if earnings do fall then inflation probably will as well and therefore rate expectations will moderate providing a partial offset. At the moment we seem to have priced in a mild recession and inflation that is not transitory but will eventually moderate as the economy cools down and supply chain issues resolve. So I think to get a much deeper decline in markets you would really need to see either a rather severe recession (which seems unlikely and if it did materialize would probably be used to justify a Fed pivot) and/or the Fed being very aggressive on rate hikes and QT contrary to the general consensus that after a few more hikes they will be done or some kind of black swan.

Clearly fundamentals are still good with tight supply and demand destruction fears are probably overblown as there is a big appetite for travel and demand is to a large extent inelastic. And even at $100 oil energy companies mint money and trade at very low multiples. Difficulties I am having is: a) It is still a speculative market and energy is the most popular long trade at the moment so a lot of the demand is speculative and therefore the oil price may have got ahead of itself. and recession fears and any sign the Ukraine war is close to ending could bring prices down even more than we've seen to date b) To some extent low multiples are justified because there is a lot of uncertainty about the future of the industry and with little new investment a lot of energy companies are basically in run off so even with generous dividends and so on a lot of it might just a be a return of capital Any thoughts on this?

I don't think it is unreasonable to expect more material downside especially if we are indeed heading into recession which is seeming more and more likely. The average recessionary bear market sees a drop of 30-40% and while the market peak in 2021 wasn't as insane as 2000 or 1929 it was certainly expensive by historical standards and underpinned by an assumption that interest rates would continue to stay low and the Fed would continue to be supportive and we were in for another Roaring 20s in other words the usual blue sky assumptions that take hold at secular market peaks and shatter confidence when proven to be false and market moves tend to go too far in both directions ("Mr Market"). Also you don't have to make apocalyptic assumptions to justify lower market levels. I think one Bank of America scenario is that 2023 earnings estimates fall to around $200 and a 15x multiple (to reflect the higher rate environment) results in a valuation of 3000 which would be around a 35% peak to trough decline. So you don't need to assume an extreme bear market scenario where we end up with single digit PE ratios or anything crazy like that. Or even much more than a garden variety earnings recession. And really that would just take us back to where we were before the pandemic with the somewhat higher earning power offset by somewhat lower multiples to reflect a higher rate environment.

I am a UK investor so while I have cash to put to work in the coming months if stock markets continue to slide a lot of the benefits are offset byhaving a lot less purchasing power as the £ has fallen from a post Brexit high of around $1.40/£ to a current level approaching $1.20/£. And Bank of England looks like it will be far less aggressive than the Fed in terms of rate hikes and seems far more likely to fall into a recession given the greater exposure to the Ukraine war and potential vulnerability re the housing market with most mortgages variable or on short term fixes so quite vulnerable to even modest interest rate rikes and with far more modest fiscal stimulus post pandemic we didn't rebound as strongly as the US. So seems like there is further downside vulnerability. I am fairly confident that markets are heading quite a lot lower but if the pound tumbles down to close to parity with the dollar that will offset most of the benefits of having cash available to deploy at a lower level. What are peoples' thoughts re the outlook for the GBP and what are some good ways to hedge my exposure? I was thinking possibly buying some short term US treasuries as any losses will be modest as interest rates rise and might even be offset by FX gains.

I don't see how giving up some more of the gains of the last 2 years is going to be that ruinous. Especially within the context of the last decade when the stock market returned over 10% a year in real terms. The Fed can do little about the major causes of the inflation (excessive fiscal stimulus and supply chain issues) but central banking is a confidence game and it needs to rebuild its credibility after letting inflation spiral out of control on its watch. Otherwise inflation expectations will get embedded into the system long after the root causes dissipate and moral hazard will mean that risk appetite returns and we get more misallocation of capital into ridiculous stocks and NFTs. But I agree the Fed is attributed with an unjustified omnipotence. Certainly they can move markets. But if the economy goes into recession it won't be because the Fed increased rates by a couple hundred basis points. It will be because when economies overheat there is usually a hangover and the combination of excessive stimulus and supply shocks is the equivalent of mixing drinks and will make the hangover a lot worse.

Gregmal: what about technology? That seems the obvious fundamental shift as hybrid/remote working will persist and there is also a lot more e-commerce as the pandemic encouraged late adoption e.g. the elderly etc. and with people working from home more frequently it is easier to schedule deliveries etc. Although there is an argument that a lot of investment has been pulled forward and higher earning power post pandemic will be offset by lower growth prospects going forward not to mention that if we are heading into a recession there will be capex cuts. And with e-commerce obviously spending is being diverted towards services, fuel etc. Grantham believes strongly in long term inflationary trends driven by resources scarcity and tight labour markets due to demographic factors. Question is whether the central banks decide to accommodate this inflation in the usual way or whether they will be forced to return interest rates to more normal levels which will be tough medicine given all the debt in the world. Re climate change from what I have read about the subject as things stand the only real hope of achieving the climate change ambitions is to sacrifice economic growth. That obviously has implications for the world economy when it has been taken for granted that over the long term economic growth is a given.

Lesson from the 70s is that in the transition to an inflationary era paying high multiples especially for growth stocks doesn't work out too great. Especially if the central bank is serious about doing something about the inflation. I'm not convinced we are heading towards an inflationary era. Perhaps in relation to commodity prices given resource scarcity and governments making it difficult to bring new supply online. But aggregate demand will cool down as all the stimulus wears off and supply chain issues will ease and the labour market should normalize as well. At the same time the inflation genie is out of the bottle which probably does mean that there will be more cyclicality (as the Fed can no longer prioritize full employment) and interest rates will probably have to average a lot higher than the last decade and both factors are negatives for stock prices and while the FANG stocks should continue to do well they won't be as supportive of stock price appreciation as they have been over the last 10 years and multiple compression could be a headwind. Accompanying multiple compression could be some margin compression. Since the GFC earnings have grown a lot faster than revenues helped by margin compression and buybacks using cheap debt. I think going forward earnings growth will be more closely tied to GDP growth.

Seems to be some confidence that core inflation has peaked and is heading lower and the Fed isn't going to be that aggressive frontloading with a few hikes and then when it is clear core inflation is starting to decline they can press pause and take a wait and see approach. So I think assuming earnings hold up it could be another near bear market and the bull market will resume and continue its long run. And even if earnings do fall a Fed pivot will help markets to look through a mild recession. I think at this point the only downside risk is that there are a lot more earnings disappointments in subsequent quarters and a recession coincides with inflation still sufficiently high that the Fed's hands are tied and it is unable to pivot and slash rates and print money.

I think it is a bit of an Emperor's clothes type situation. The fiscal stimulus is wearing off and the Fed has stopped adding fuel to the fire (for now) and temporarily spending can exceed incomes because of the savings amassed during the pandemic and the addiction to cheap debt. But a lot of those savings are leaking out of the economy (huge trade deficit in Q1) and elevated energy and food prices and rising credit card and mortgage rates will make a dent in the rest. The Fed and markets believe in a soft landing and inflation moderating. I think for the most part the share price declines so far are pricing in a) reallocation of spending to the detriment of a lot of pandemic winners b) somewhat higher rates and therefore discount rates punishing growth stocks c) somewhat lower earnings as a result of a mild slowdown in the economy and cost pressures related to supply chain disruptions/fuel price inflation etc. We may have flirted with the 20% bear market cut off on the S&P 500 but really we are still in correction territory. And bull markets do not end with corrections. They just pause and when the clouds clear and confidence returns the bull market resumes. And in this long run we have already had quite a few near bear markets. I'm not saying we are heading for a 50% decline because those do coincide with something exceptional. But a 30-40% bear market especially from a speculative peak doesn't seem unthinkable if we do not have the soft landing markets anticipate or the Fed is forced to be more aggressive than it is currently guiding. And it does kinda feel like end of an era. The bull market was fuelled by cheap money and with the inflation genie out of the bottle the Fed will probably be forced to at least keep things at neutral and turn off the QE taps even if it doesn't end up having to aggressively tighten. And the FANGAM stocks have been responsible for a large portion of the gains in the latter half of the last decade and it is difficult to see them growing at the same kind of rate and multiple compression could continue to be a tailwind. Nor does it seem likely that the economy will do the heavy lifting. In the post GFC era even with all the explosion of debt growth has only very rarely topped 3%.

"That being said, the market is 18.7x for trailing 2021 EPS (5.3% earnings yield), and much cheaper on a forward looking basis. Meh." I think this is the real issue. 2021 earnings were inflated for many companies because of changing spending patterns during the pandemic and for the most part they were able to pass on higher input prices as consumers were relatively flush with cash. Not to mention the delayed impact of the massive amounts of fiscal and monetary stimulus. Forward looking estimates are inaccurate at the best of times but it seems quite possible that 2021 were peak earnings for this cycle and 2022 earnings will come in lower. How much lower is tough to guess. But 19x is a generous multiple to pay for peak earnings so could be a lot further room for disappointment as lower earnings and lower multiples kick in.

Kuppy @ adventures in capitalism has an interesting take on how things will play out. Not sure if I am allowed to link the article on here but will summarize it briefly: Inflation is primarily a supply side problem which the government are making worse Fed is under political pressure to do something But they don't want to crash markets So they are hoping that once things start to break Congress will start to worry about falling asset prices allowing them to pause and take a wait and see approach Inflation won't go away and therefore commodities are the place to be Thoughts?

I think the bear case is simply peak earnings and peak multiples means there is some distance to travel. 2021 earnings were inflated by the temporary boon e-commerce, cloud companies, consumer goods companies etc got from the pandemic and an economy pumped above its productive capacity by excessive levels of stimulus. 2021 P/E multiples were inflated by zero interest rate policies, QE and a lot of optimism about technology, the recovery and the moral hazard of knowing the Fed has the market's back. We've already seen a slowdown/decline in earnings in a lot of technology and e-commerce companies and future quarters may see further declines especially if the global economy goes into recession. And even if you think the US can achieve a soft landing the rest of the world might not be so lucky and therefore foreign earnings of US companies may decline significantly. A lot of tech/e-commerce companies doubled their earning power compared to pre-pandemic levels and a good portion of that increase is unlikely to be sustainable. The fiscal and monetary stimulus is wearing off. There are margin pressures from rising input costs and wages. Capacity constraints due to supply shortages. Obviously rates are going up and the Fed is going to suck some of the liquidity out of the system. The S&P 500 has a high concentration (by market cap) in growth stocks and they are very vulnerable to multiple compression following rising rates and earnings disappointments. Confidence in the Fed put is declining. And generally confidence is declining and this has a big impact on the willingness of investors to pay high multiples for stocks. There are also some technical factors. For example as the bond bubble continues to burst and bond prices decline that requires rebalancing. And deleveraging also has a big impact on buying power and there is contagion as losses on the more speculative stuff require hedge funds etc to sell their more liquid holdings. And a lot of people are still bullish or at least relatively sanguine believing the economy is strong enough to handle rate increases and QT and inflation is close to peaking and will come down pretty quickly and any recession will be relatively mild and the Fed is all bark and no bite and will rescue markets if they go much lower or if there are signs of economic weakness. Of course this may turn out to be true in which case buying the dip continues to be good advice. But if this optimism is misplaced then more people will convert from bulls to bears and markets could go a lot lower via lower earnings and lower multiples.

I think it remains to be seen how strong the economy is now the Fed is no longer being so accommodating and the fiscal stimulus is wearing off and inflation continues to rage. Now it is clear inflation is not transitory and the economy is heading south companies are more likely to consider cost cutting measures such as laying off staff etc or cutting back on growth capex. As for the consumer after using stimulus checks to pay down credit card debt credit card debt is now back towards record highs and APRs are heading higher which doesn't feel like an indicator of health. And it is not just food and energy that is a lot more expensive housing costs are going up and travel is a lot more expensive and that is going to mean cuts in other areas of spending and we've already seen e-commerce companies take a hit in anticipation of this. And then of course there is precautionary saving as recession fears build and the negative wealth effect as asset prices fall. Agree with Viking that all of this will take some time to play out. At this point in time markets are mostly pricing in probabilities and these probabilities will change as we get more information from future Fed guidance, company guidance, economic and company data releases etc. In simple terms if we are going to get the soft landing we are probably close to the bottom. If we are going to get a hard landing we are probably only halfway there. And of course if the Fed pivots and turns on the printing presses again then we will probably quickly recover to all time highs (in nominal if not real terms).

https://www.bloomberg.com/opinion/articles/2022-05-11/sterling-s-drop-to-parity-with-the-dollar-is-a-real-risk?cmpid%3D=socialflow-twitter-bloomberguk&utm_content=bloomberguk&utm_source=twitter&utm_campaign=socialflow-organic&utm_medium=social Article above is pretty good and sheds some light. Markets seem to believe that the US economy is stronger than the others and can therefore withstand more interest rate rises before something breaks. UK economy is headed to recession with little assistance required from the BOE which limits their room to raise rates.

Dollar reached a 20 year high against other major currencies (as measured by the dollar index). I can understand the appeal as: a) Dollar is a safe haven and times are scary b) Treasury yields in the US are higher than other developed countries so good place to park cash c) US is the strongest economy in the developed world and its stock market has outperformed this cycle by some distance d) A lot of money has been attracted to the US stock market to invest in technology stocks etc. On the other hands you have some pretty massive twin deficits and the PPP theory of exchange rates suggests considerable overvaluation and the historical precedent after similar occasions of dollar strength e.g. late 60s, mid 80s, early 00s was multi-year declines: In the 1970s USD fell > 30% in real terms over 9 years In the mid-1980s to mid-1990s USD fell > 35% in real terms over 10 years In the 2000s USD fell > 25% in real terms over 9 years Any thoughts?

Other difference with late 2018 is that the bottom of 2500 was cheap representing around 15x earnings compared to a 10 year of 2-3%. Also at the bottom split adjusted you could have scooped up Apple at $40, Microsoft at $100, Facebook at $130, Google at $1000 and obviously their performance from that date drove a lot of the appreciation to date. Even after a 15% decline we are trading at around 20x earnings and I think 2021 earnings are probably peak earnings for this cycle. The best quality mega tech stocks such as Apple and Microsoft aren't close to being cheap. And while Facebook and Netflix have sold off considerably they are facing challenges to their business models with data privacy and competition respectively. Also there was a soft landing end of 2018 with only a very mild slowdown driven by trade wars etc. Whereas we are probably heading into recession later this year. And of course inflation is going to pressure margins and make it a lot harder for the Fed to rescue markets. I think the main parallel with 2018 is the speed of the decline and most likely this is a leg down with a near term bottom but it is difficult to imagine a V shaped recovery and a swift move to much much higher levels. Most likely 4800 was the peak for this bull market and depending on how things turn out for the global economy and depending on Fed policy we will either go sideways with a lot of volatility or head a lot lower

I think the dynamics are very similar to the 2018 flash crash but I agree that what happens next will probably be different. I think this will be a leg down in a bear market rather than a correction that was overdone. The Fed isn't in a position to flood the market with liquidity and while things could turn out a lot better than the market is expecting (soft landing, inflation eases, not much further for rates to go, Fed rescues the market before things get really bad) they could also turn out a lot worse (hard landing, inflation still rages, Fed presses ahead with rate increases refuses to rescue the market). So I think once the selling pressure eases the market will probably go sideways for a while until we get a better handle on what comes next and markets will monitor closer Q2 company releases and economic data. Oh and final snippet of the Dimon quote is interesting re excessive moves in the market....fundamentals do matter but technical factors and sentiment might mean we bottom below fair value (which I peg at around the 3200 pre-COVID market level)

Below 4000 for the first time since end of Q1 2021! Even oil got crushed today. Not very long before we enter bear market territory for the S&P 500. . Feels a bit different from the barely bear markets of 2011/12 and 2018 which were short reversals in the long long bull market and from much more reasonably valued market levels. Of course a bear market rally would be typical and there is likely to be a lot more volatility before the actual low is reached which might not be until later this year or even next year. But 30-35% decline seems more likely unless there is a soft landing and inflation cools more quickly than expected or the Fed decides to rescue the stock market even with inflation still roaring.

How much downside? So far despite all the dramatics the overall index is only down 15% or so from a market top that was clearly based on unrealistic expectations about the economic recovery ("The Roaring 20s") and tech optimism ("The New Normal") as well as an assumption that inflation was transitory and the Fed would keep interest rates low and continue rescuing markets at the first sign of trouble. And usually that level of confidence is only found at the end of a multi-year secular bull market and they generally end with 30-50% declines. .

There is a huge amount of uncertainty so the market is necessarily very reactive and I think that means the range of outcomes is massive. Re earnings: what will earnings look like in a post-pandemic inflationary environment? And if we go into recession this year how low will earnings go? Re interest rates: how much higher will they go before it is clear the tide has turned with inflation or the Fed figures the damage to the stock market/economy is too great and reverses course? I think earnings could be the bigger factor. Earnings yields have been fairly consistently around 5-6% in the modern era despite the variability in interest rates. S&P 500 earnings in 2021 will be around $210. That compares to $160 pre-pandemic. But most likely they represent peak earnings. Big Tech have for some time been able to experience impressive secular growth in a sluggish economy and the pandemic was a massive boon for them. But they are so big that you'd imagine their earnings would not be immune from declines in a recession. Consumer discretionary companies have benefited from consumers receiving stimmies, cutting back on travel, and online shopping out of boredom and with more money going to energy and food consumers will have to cut back. Consumer staples companies could suffer as they are unable to pass on all their cost increases and consumers start thinking about switching to non-branded alternatives. Financials are vulnerable to higher credit losses and a possible housing market correction. Commodities will suffer if demand falls in a global recession. Wall Street are bringing down their 2022 estimates but they are still higher than 2021. But in an average recession S&P 500 earnings decline around 25% which would get us right back to where we were pre-pandemic and could erase the remainder of the post-pandemic market price gains.

I think earnings matter far more than interest rates. And what we are seeing in a lot of companies is that earnings gains during the pandemic were not sustainable either for cyclical reasons (we are heading back towards a recession) or because of changes in spending patterns (consumers aren't spending as much online and businesses will probably have to cut back on advertizing etc). And it is interesting how many companies have gone on complete roundtrips back to their pre-pandemic levels or lower with the likes of FB, AMZN, JPM, BAC prominent examples of this. So it is somewhat of a surprise to me that the market is still 20% higher. Obviously there has been a bit of a rotation towards defensives and things like consumer staples and utilities have done well, and commodities while a small component of the index have been on a roll, and the likes of APPL and MSFT have held on to a lot of their pandemic gains. But it suggests some vulnerability as inflation was much lower pre-pandemic and while the economy was slowing a recession wasn't imminent until COVID hit. Generally bear markets do coincide with recessions. So what happens next depends a lot on whether we go into a recession and how severe it is. An average recession brings S&P 500 earnings down around 25%. Taking 2021 earnings of around $210 that would bring us back to around $160 right in line with pre-pandemic earnigns and even if you still give a 20x multiple to that (despite interest rates going higher) that gets you to 3200 on the S&P 500 which suggests quite a bit of downside and is also consistent with the idea of the market giving up all of its pandemic gains which is the usual outcome if most of these gains can be attributed to speculation/cyclical/temporary factors. Of course how low we go also depends on at what point the Fed pivots, slashes interest rates and prints a bunch of money. And I don't think we know yet whether the Fed's hands are tied because of inflation. Most of their confidence in pressing forward with rate increases seems to be based on their belief that the economy is still pretty strong and they can engineer a soft landing. And they don't really care about the speculative stuff selling off when the overall market is holding up pretty well. Whether that changes if markets continue to fall and economic data worsens remains to be seen.