Sovereign Wealth Partners and InvestSense Pty Ltd
Markets capped off a strong month with the US market up 9%, following a 4% gain in the last week alone. The US earnings season surprised weak expectations (especially for large tech stocks) and the Nasdaq performed even better. However, once again it seems that inflation and interest rate expectations were the real driver as weak economic data gave investors some ‘hope’ that the Federal Reserve was seeing some early success in slowing the US economy giving pause to interest rate rises, including a second consecutive quarter of economic contraction (something which some, not all, call a recession).
On the other hand, inflation measures, including the Fed’s preferred Personal Consumption Expenditures continued to rise (the PCE is abroad ‘core’ measure of inflation based on actual economic activity rather than surveys and notional baskets as is the case with the Consumer Price Index). In absolute terms it is, as usual, a little lower than CPI (6.9% for the last 12 months and 4.8% excluding food and energy) but the direction of travel remains upwards on a monthly basis. What matters to markets though, is what the net impact on bond rates is and consequently, long bond rates have moved down by about 0.5% in the last month.
All that meant that the US tech giants led the market and made the biggest contribution, while perhaps surprisingly, UK, European and Australian markets kept pace in the last week while Asia and Japan were flat. For the month as a whole Japan and Australia almost kept up with the US while Europe was flat and Emerging markets were down a few percent. In the latter case the continued strength of the US Dollar has weighed on sentiment and into the end of the month concerns focused particularly on the debt laden property sector and a potentially deepening recession.
We are not convinced that 1) equity markets have fully discounted the impact of a probable recession (as witnessed by largely sanguine earnings forecasts) and 2) any one really understands what the potential unintended consequences of quantitative tightening are. That is probably the knottiest and most technical of issues to work through but there is another simpler metric that gives us pause for thought and one which directly addresses the concept of turning points vs bear market rallies. The recent rally is more or less par for the course for the volatility we have seen so far this year – if markets fall a lot they are going to bounce around in both directions. Furthermore, as markets get cheaper the bounces are likely to get greater as the distance from previous highs gets bigger and valuation support (more buyers) increases.
The closest analog that most pundits point to are the rallies of 2001 and 2002 after the Dot Com bust, which wouldn’t bode well as that was a long and protracted bear market. When we overlay a valuation driven view of the world it is striking that at all the major turning points (1974, 1982, late 1987, 1995, 2003 and early 2009) the market was demonstrably cheap (in our parlance displaying the potential for expected returns of 10% or more). On that basis the US especially would seem to be ‘not quite there yet’.
That said markets do a very good job of not repeating themselves and making fools of those who expect them to. There could be some positive catalysts that could turn this latest rally into a turning point, at least on a 2–3-year time horizon. As an example, one of those things that is being talked less and less about is a potential resolution to the Ukraine War. Such an occurrence would likely give markets another leg up and perhaps be the start of a protracted rally.