mattee2264

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.

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.