Note Précis January 3,2019: Assess Market Continuum Over Distinct Frames – Phrases like risk on/risk off and santa claus rally in markets or for that matter use of breaking news generally may sound pithy but in fact tend to reinforce considering events as distinct frames. However and much as in motion pictures, going frame by frame does risk missing the continuum in markets. In order to assay the market continuum, we have deliberately refrained from commentary during the last several weeks.
In our assessment, central banks overshot in expanding quantitative ease from as long ago as 2013. It resulted in among other things in laxity in fiscal deficits and corporate leverage. Seen in this context, the Federal Reserve increases in Fed Funds rates and reduced quantitative ease seems an overdue check. Further, it is often misunderstood by domestically and populist oriented governments that actions have international consequences. Other politicians in other countries have their own imperatives. Then, the capital markets themselves have long histories of excess on the subject du jour to be followed by reassessment. In this cycle, the subject du jour has been the scale and duration of quantitative ease. Still, in fixed income markets, CCC junk bond yields at 13.6% are up some 400 basis points from their recent lows. Not to be overlooked has been euphoria over social media and among companies, penchant for financial engineering. Related equity valuation still has to fully account for such change.
Fraught with risk at mature phases of a cycle is using forward earnings to calculate equity valuations for indices like the S&P 500, comparing them to recent valuation levels and then proclaiming them to be inexpensive. Equities tend to peak at high levels precisely because turbulence was unanticipated. In the last three decades, over the 1988 onwards cycle and then again in their 2000 onwards cycle, S&P 500 earnings dropped 20-25% and in extremis, in their 2008 cycle dropped over 40%. Global GDP growth appears widely expected to trend around 3.7% annually, or midway to recession and meaningfully below a two decade average of 4% annually. Even if recession is avoided and earnings growth were to be flat at around 0-5% for the S&P 500, equity valuation can scarcely be defined as cheap.
Seen in continuum and despite the modern advent of computational power, reappraisal is evident with major market point swings, otherwise defined as volatility. It seems more realistically as being a result of misjudging the stability of the fundamentals of economies and companies alike. We expect it to continue into mid-year. As is classical, the Financials sector will likely give the early indications of recovery.
StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.