Rudi's View | Jul 07 2022
-Are We There Yet?
-Asset Classes Over The Decades
By Rudi Filapek-Vandyck, Editor FNArena
Are We There Yet?
Bank of America Securities Chief Investment Strategist Michael Hartnett put it as follows when the June results of the global fund manager survey were released mid last month:
"...history is no guide to future performance but if it were, today's bear market would end on Oct 19th 2022 with the S&P 500 at 3000".
On Friday, the S&P500 closed at 3825.33 - 21.5% above the suggested bottom.
Of course, history is not a perfect guide and sometimes it is no useful guide at all. Besides, when it comes to humans, patience is not our biggest virtue, especially not when share prices already are down -35%, -50%, -75%, and more!
May was a pretty lousy month for Australian equities, but June was simply heart wrenching, making sure the average portfolio is now down compared with twelve months ago. So surely, markets must be approaching The Bottom, yes? (Let's ignore BofA and history for a moment).
For what it's worth, it is my observation the more defensive, Quality stalwarts on the ASX are showing early signals of what might well turn out to be an embryonic bottoming trajectory on price charts; look up CSL ((CSL)), for example, or ResMed ((RMD)), but this doesn't tell us anything about where inflation is heading, or bond yields, or corporate margins and profits in general.
And those items, rather than today's share prices, will determine the low and the future of local and global equities.
There are multiple signs that inflation might soon stop rising. Look at the price of copper, for example. And bond yields are retreating as the focus shifts to the rising probability for a US and even a global recession, possibly ex-Australia, over the year ahead. But central banks are still tightening.
The latter is important. History shows, the Wall Street Journal reported two weeks ago, markets don't find a bottom until there's no more tightening and central bankers start preparing for rate cuts instead.
Within this context, I find the latest change of heart by strategists at stockbroker Morgans quite telling.
"We think the rises in global government bond yields and falls in equity prices have further to run", strategists Andrew Tang and Tom Sartor revealed in their latest update, "Government bond yields have typically peaked shortly before the end of central bank tightening cycles and we expect most major central banks to continue hiking rates over the next 12 months."
Unsurprisingly, both strategists see more downside potential over the months ahead -quite the opposite of The Bottom- as the combination of high inflation, high bond yields, still tightening central banks and slowing economic growth firmly keeps risks to the downside.
The good news is that as this scenario plays out, the end of tightening might ultimately not be that far off. At some point over the coming months, financial markets will sniff out that the Federal Reserve no longer has much more tightening to do, and that realisation most likely will allow markets to front-run (so to speak) the change in central bank policies.
Morgans refers to "later this year". Others, including Morgan Stanley strategist Mike Wilson suggest The Bottom might happen in the fourth quarter of 2022.
The second key dynamic that is weighing upon equities this year is the widespread anticipation that corporate profits will not keep up with present forecasts, and thus expectations need to be lowered in the form of cuts to consensus estimates (see also further below).
Again, history suggests, this is a process vital for equity markets to find a bottom and prepare for the next bull market. But history also shows this is a multi-month process.
A few snippets from a recent report by Morgan Stanley:
-equity markets tend to bottom on average 2-3 weeks before the consensus earnings revision ratio troughs;
-the average time taken between the date of the first move into negative earnings revisions and the trough in revisions (i.e. maximum downgrades) is 7-8 months;
-the quickest transition recorded thus far still required approximately 3 months
"Given that earnings revisions for MSCI Europe currently remain positive, this timetable would imply that we are still a few months away from a likely bottom in equity indices."
I'd argue what applies to Europe, equally applies to Australia and the USA.
Of course, none of this will prevent the industry from embracing the next calls that The Bottom is in. And again. And yes, again. Until it -finally- happens.
Don't be impatient. Make sure the recession, real or mild or otherwise, doesn't evaporate your capital.
More Weekly Insights to read:
-Balancing Between Opportunity & Risks: https://www.fnarena.com/index.php/2022/06/30/rudis-view-balancing-between-opportunity-risks/
-Not the Bottom, Not The End: https://www.fnarena.com/index.php/2022/06/23/rudis-view-not-the-bottom-not-the-end/
-Double Your Protection: https://www.fnarena.com/index.php/2022/03/17/rudis-view-double-your-protection/
This is no longer an audacious, left-of-centre view, but analysts forecasts seem too rosy and a reset needs to occur.
This reset, ultimately, will determine how much 'value' is genuinely on offer in equities, at least for the next 12-18 months.
So how much of a reduction should investors -realistically- prepare for?
The magic number, it appears, is -20%. In recent weeks market strategists both in the US and locally have mentioned the number as a good reference point for how much of a general reset needs to occur in the months ahead.
Investors should note that when the likes of Morgan Stanley strategist Mike Wilson and UBS's Richard Schellbach mention this number, they do not include a severe, long-lasting recession in their forward modeling. Hence theirs is not a worst case scenario.
Why are forecasts too high?