Note Précis Nov. 24,2023: Risk Amid Neither-Nor Markets. The equity markets such as the S&P 500 as benchmark appear neither able to reach beyond the highs set at year end 2021. After a decade and half of gains from credit crisis lows, nor do equity markets appear to be willing, to sustain a classical correction node to weed out built up excesses. The investment risks encompass much in linkages to long term valuation, short term operational company challenges and not least, monetary, fiscal and geopolitical policies. Credit risk has yet to be fleshed out from higher administered rates (above 5% in many jurisdictions after being minimal) and prolonged monetary tightening. Interregnums are not everlasting.
Over 2023 to date in capital markets, momentum continues to flash and then brusquely diminish. We would divide driving forces in capital markets in 2023 into thirds. In the first third, the trend appeared to incorporate economic growth recovery but also early policy ease via lower administered rates. Earnings expectations were optimistic and valuation parameters stable. In the mid third, as Fed Funds rates exceeded 5% amid global quantitative tightening, credit spreads in fixed income increased bifurcation. Corporate result consensus expectations for companies decreased and greater focus developed on valuation, especially with banking stress in the U.S. and Europe as well as ongoing in China and Japan. Then in the last third to date, momentum strategies have again reared, albeit with artificial intelligence and a different set of Information Technology leaders.
The environment seems one of slow and bifurcated economic growth with central banks espousing an elevated administered rate environment for longer amid extended fiscal realities. Between sovereign credits and within corporate tiers, in momentum lite as compared to equities, we see credit spread adjustments in Fixed Income as being incomplete especially for long maturities. In equities, we assess corporations as having to adjust to operational challenges, a less conducive financial engineering environment. Consensus earnings and especially valuations are likely to become more circumspect. A switch from momentum and financial engineering to value and quality balance appears incomplete, not least in the crucial Financials sector. A slower asset growth and greater quality focus may be needed, despite several AT1 and synthetic risk swap forays.
Equities again appear to espouse an early pause/cut in administered rates and quantitative tightening. Merely beating oft reduced consensus appears being taken as a momentum success. As is classical in global business cycles, the U.S. consumer did provide fortitude but marquee companies have indicated caution about future gains. Systemic risk in finance often surprises. On resurgent and narrow momentum leadership, the 1999/2000 TMT excess apparently was revealed to not being limited to retail investors.
Equity valuation globally is not low. Evergreen consensus appears of 10% earnings growth for the S&P 500 for the nearest out year which oft times is then reduced., Our S&P 500 earnings expectation is for less than 5% growth for 2024. Equities are likely to need readjustment to bifurcated (even if positive overall) economic global growth and to political economy stresses. Such adjustments are likely to limit geographical rotation advantages. Likely to favor quality and diversification are bifurcation of delivery within sectors and central banks focusing on continued policies to tame inflation. E.o.e.