Market valuations
Are markets expensive? The US certainly is, looked at against its own history. Earnings might be “exploding” after lock down, but can the pace of acceleration be maintained, as it will have to, to maintain current valuation levels. I say, “unlikely”, as companies are already facing margin pressure from supply chain issues and rising inflation of goods, services and labour. Here is the summary of a recent piece by John Hussman which is well worth a read. Hussman Market Comment
So 10, 20, or possibly even 30 years from today, investors may look back on years of low or negative total returns and say, well, nobody could have predicted X about the economy, or inflation, or debt, or whatever. What I’m trying to tell you is that it doesn’t matter. The moment you look at where starting valuations are, you already know that, in all probability, the prospects for acceptable stock market returns are screwed. You just don’t quite know what type of screw.
What is strange about this, and disconcerting, is that the optimism is reaching these peaks in a situation where confidence in growth has declined, and fears of rising inflation and rates are back. Bonds indeed don’t look like a buy — but a lot is being built on the notion that they leave us no alternative but to buy something more risky. John Authers - Bloomberg
Another brake on the US economy is Biden’s vaccine policy. According to Luke Gromen at Forest for the Trees, LLC - Home (fftt-llc.com) there would seem to be two most likely outcomes:
Biden revokes his vaccine mandate, and US job and economic growth surges, allowing the Fed the breathing room to truly Taper QE and withdraw liquidity without blowing up markets (this option is unlikely in our view, but would likely be good news for stocks, commodities, the USD, and likely bad for USTs (rates up), gold, & vaccine makers.)
Biden sticks to his mandate, job growth remains disappointing while wage inflation continues to rise, and the US government is forced to increase unemployment stimulus or issue another round of stimulus, and/or the Fed is forced to delay QE Taper or up size QE, into accelerating inflation (this is the most likely outcome in his view; and ours.)
Biden may have announced trying to help the supply chain problem at US west coast ports last week, but his mandate will likely more than offset any help US government efforts there do in terms of supply chain problems and stagflationary pressures in coming weeks if it is not reversed.
There is also the issue of strong union control of the ports in California that don’t allow non-union trucks (most of the single trucker drivers of which there are many) into the port.
The value / growth debate continues
with markets beginning to tilt towards value again Callum Thomas at About Topdown Charts - independent investment research has this to say.
Value vs Growth Relative Valuations We suggest taking a nuanced perspective on “Value vs Growth“ by breaking it down into the sector tilts that result from the typical value/growth filters. In this respect we note how “Cyclical Value“ (i.e Energy and Financials) are trading near record low valuations relative to the rest of the market, despite a decent rebound already. This discount is also deeper than what we see for defensive value (which is also attractive relative to the rest of the market). Given that cyclical value tends to benefit from the part of the cycle where you see rising real activity and inflation (and rising commodity prices and bond yields), we see this as the logical leader for value stocks in the immediate term - with it likely that defensive value takes the baton later in the cycle.
Key point: Cyclical Value is set to lead the first wave for value vs growth.
On inflation – having been around in the 70s this quote from Eswar Prasad’s The Future of Money rang a few bells…alarm bells!
Stepping back for a moment, I can’t help but wonder if the pandemic’s disruptive effect on global supply chains is in some ways similar to the 1973 oil shock. When oil prices spiked in 1973/1974 due to the Saudi oil embargo, US inflation rose quickly because the American economy was set up for structurally low energy prices. When gasoline prices tripled in a year, for example, the supply chain for everything from food to apparel to durable goods had to pass along those costs. You know how that story ended: another oil shock in 1979 forced Paul Volcker’s Fed to raise interest rates to dampen demand and bring inflation back under control. Let’s hope history does not repeat itself in 2022.
In similar vein from Luke Gromen again.
To our eyes, Wall Street continues to underestimate the risk that China acts as OPEC did in the 1970s with oil – “Oh, you’re going to do political things that we don’t like, USA? Fine, then you are going to pay more for Chinese-made goods. A lot more.”
How can inflation be transitory if supply chain disruptions are here to stay? It likely can’t be. But critically, unlike the 1970s when US debt/GDP was 25-30% instead of the 125-130% it is today, the Fed CANNOT run “the Paul Volcker playbook” to hike rates and contain inflation without putting the US government at risk of a debt crisis with Treasury Spending + Entitlement Pay-Go’s running above tax receipts (US debt crisis = US equity markets down, US Treasury yields up.)
This is critical to understand and is key to asset allocation decisions.
The net effect of this seems to be that the global economy will fall into recession or worse in 2022, thanks to high energy prices. You have been warned…