‘It gets very dark before dawn’
A number of issues at the start of the fourth quarter are in our view worth examining.
A) Stock indices
September performance lived up to its strange reputation. It was ugly recording double digit drops !The worst performance since the awful month with Covid of March 2020.
But so were the quarter and the year to date stock performances :
The SandP has recorded a drop of 25.2 pct and the Nasdaq of 33.5 pct ytd.
B) Other Assets
Inflation data and increased inflationary expectations led to Interest rate increases across the
Yield curve and left no investment assets to hide!
-The 5y TBond dropped 10.7 pct and the 10y TBond 16.7 pct. year to date.
-Gold dropped 8.1 pct.
-Housing with its notorious sensitivity to interest rates has already started to crack and
will follow suit.
-The only place to hide was cash in USD : The dollar index appreciated by 16.9 pct !
ΙΙ ) The List Problems
A) The FED.
The performance of the FED was dismal. It maintained for too long that inflation was transitory.
On the contrary it proved to be persistent. Now the FED increases interest rates too fast. But time lags of monetary policy are long variable and uncertain. Tightening might eventually prove excessive accentuating an eventual cycle and throwing the economy into recession. The members probably owe a big apology !
B) Geopolitical factors
The war in Ukraine, led to dramatic increases in the price of oil and of agricultural goods fueling
further the inflationary problems. Supply chain issues affected adversely the world economy. Unfortunately, these issues are not resolved and the risk of nuclear escalation remains…
C) UK budget
The markets have strongly disagreed with the Torries new plan.
Tax cuts are expected to create growth and increased tax revenues in the future.
As a result, government Spending needed to stabilize energy costs have to be financed from other sources.The result is interest rate and currency shocks that might spread around the globe.
(On Monday October 3, in an effort to calm markets, the government in a major twist announced a decision not to proceed with the abolishment of the top rate tax).
D) Covid supply chains and hurricane Ian.
The zero Covid policy of China created some additional supply side constraints.
This great problem appears to be move towards normalisations. However, the Florida disaster provides an additional shock.
III)The Prospects of the key variables
A) inflation announcements of different measures continue to be stubbornly high and above
B) inflationary expectations have decreased. Now according to the NY Fed (for August)they have decreased to 5.7 pct for one year, 2.3pct for three years and 2.0 pct for five years. On this front the FED becomes credible !
C) S and P Earnings are revised downwards. Consensus appears to be Usd 215 for 2022 and
usd 235 for 2023.
IV) Conclusion for stabilization.
A) We desperately need a drop in future inflation statistics and on inflationary expectations.
These will determine the P/E ratio. Lower inflation will make a higher P/E possible.
B) Mild recession earnings of usd 235 or more serious slowdown earnings of usd 200 will materialize ?
C) We all guessing the P/E and the earnings :
15x 200 equals 3000 ? or
17 x235 equals 3995 ? or ….
The market at the end of Q3 stands at 3585.
On Jan 4, 2022 it stood at 4818 ! A different world in just nine months !
V) Old valuable advice
A) ‘Do not fight the FED ! ‘
The FED still appears to provide a headwind and not a tailwind to the markets.
B) ‘the Markets stop panicking when the FED panics !
Quantitative tightening (selling of Treasury bonds) or slowing down in the pace of interest rate increases has to take place for a change in market direction to materialize.
C) ‘Weak hands lose their shares during panics and do not participate in sudden
and longer recoveries ‘.
D) ‘The market does not discount twice’.
Being efficient or partially efficient the market has been discounting a series of bad news.
Optimists hope that news will start coming in the positive direction and will break the
atmosphere of extreme pessimism reflected in recent price levels.
VI) Concluding note
Can we endure more beating by markets or shall we gradually decrease positions to feel better ?
Will all the exogenous shocks to the economic system continue to be adverse?
Unfortunately, no answer is available for Financial Assets that fits all levels of RISK TOLERANCE !
Fortunately, non financial assets DO NOT have the benefit and curse of the possibility of immediate and partial liquidation and are thus inclined to be conserved!
Markets do not like the sudden inflationary surges and their volatility that creates uncertainty.
However, we should point out that equities eventually adjust and outperform inflation by about 6 pct.
If we have the courage, the patience and the risk tolerance we should remain invested in order to eventually enjoy this substantial extra reward !