valuations: I’ve thought that since mid-2021 the US stock market began gradually discounting the interest rate increases that the Fed finally began to implement this week.
My experience is that nothing is ever 100% factored into prices until it actually occurs. But the 10-year Treasury note is already at a yield of 2.19%, or about 50bp higher than its peak yield last year. If we assume the 10-year yield ends up at 3% by yearend, we’ve already gone (as is usually the case) a considerable way toward the final goal before any Fed action. Traditional norms suggest a 3% 10-year is compatible with a PE, based on 2022 earnings, higher than 30x for the S&P. Based on consensus earnings expectations, the S&P is currently trading at less than 20x.
This apparently favorable valuation has not come from the S&P falling that much. Instead, it’s more a function of relatively high expectations for real earnings growth this year, with a pinch of inflation tossed in.
One way (i.e., my way) of looking at market action over the past year is that the main story has been a massive rotation away from tech names into defensives that has accelerated over the past four or five months. Within tech, which even in its beaten down state is over a third of the market, there has been a similarly stark rotation away from smaller-cap and speculative names into industry giants like Alphabet, Amazon and Microsoft.
As I wrote yesterday, the aggregate numbers for performance from last year’s high through last week are:
Arguably, we’ve experienced a bear market in NASDAQ over the past four months and we may not get another 10% drop in the S&P. This is doubly so because the economy has been growing strongly throughout 2021 and is expected to continue to expand at a better-then-average pace this year.
Earlier-state tech, exemplified by the ARK funds, has been more than cut in half.
Arguably, the rich valuations are now in defensives. My guess is we’ll look back in a year and realize valuations today, maybe except for mining, are better than reasonable.
possible negatives: To my mind there are two big ones potentially in the wings. One is the possibility that Russia’s invasion of Ukraine spirals into something much bigger, as the potemkin village nature of Russia’s conventional army is exposed. I think this possibility will be a continuing PE depressant until there’s a clear resolution.
The second is that the Trump wing of the Republican party somehow gains ground. At the moment, given its pro-Russia, anti-Ukraine leanings, that’s hard to see. But my view is that, taking off my hat as a human being and donning my investor cap, Trump did so much economic damage to the US during his term (think: his NJ casinos) that his political stock rising would be accompanied by PE contraction on Wall Street.
bargain hunting: I’m not sure I see any. But I think the ARK-ish stocks that have been crushed since November will be the place to look.
capitulation: I don’t think we’ll be sure for at least a short while. I know I was, let’s say, rather disturbed earlier this week. I wasn’t October 1987 disturbed, or early 2009 disturbed, by any means. But I started to feel that maybe I’d misdiagnosed the current situation, and that things are actually much worse than I’d been thinking. To my way of thinking, that’s in a perverse way a good sign. If I’m feeling a bit shaky, what must investors who don’t have all my scars be feeling? Hopefully, panicking. Not that I wish anyone ill, but down markets often signal the end with a sharp selloff that participants almost immediately begin to regret. I don’t see that in the charts, but maybe there’s been enough AI violence along the way that we’ve had a bunch of mini-capitulations, with no energy left for a final drop. The next few days will tell a lot, I think.
To summarize: good valuation, possible wimpy capitulation, bargain hunting still up in the air (an accidental pun–I ended up buying some HOOD in the airport yesterday morning), but Russia still a wild card. Not much like the market action in 2000 or 2008. On the other hand, the charts look a lot, I think, like early 2020, when covid victims were being stacked up in refrigerator trucks. Back then, it was the US-centric Russell 2000 that collapsed–and stayed down until November–while stay-at-home stocks and multinationals rallied. To push the analogy, maybe the SPACs and the negative-cash-flow tech stocks play the role of the Russell 2000 this time around, while the rest of the market advances.