I feel good hearing the Blues
A Barrons article suggested that stocks could face lose lose situation in the coming months. Resilient growth will force the Fed to raise rates further, as a result, higher yields will make equities less attractive, or slowing growth will put pressure on earnings again making equities less attractive. Before we address this point let us take a look at what happened last week.
Stocks fell, as did bond prices, around the globe. US treasury yields rose partly in response to the continued strength of the US economy and partly to the continued supply from the US treasury. The hawkish tone of the Fed minutes did not help matters. Major US benchmarks fell for the third week on the trot. Gilt yields rose despite the further fall in year-over-year inflation, as the UK economy unexpectedly grew by 0.5% in June, and strong wage growth threatens to keep inflation rates above the Bank’s target. There was some “good news”, in a manner of speaking, as the UK unemployment rate rose to 4.2%. Adding to the gloomy picture, China’s woes continue as fears increase that the economy could be facing its own Lehman moment after Evergrande filed for Chapter 15 on Friday. Norge’s Bank raised interest rates this week reminding the world that Central Banks may not be done raising interest rates. It’s easy to see why the bears have come out to picnic
So where is the hope? Let’s not kid ourselves US equities are not cheap, but the majority of them are not expensive either. Strip out the Nvidia’s and Amazon’s of the world and the S&P is trading on 16X forward earnings, or put it another way an earnings yield of 6.5%. US ten-year yields, after last week’s rise, currently stand at 4.3%. The equity risk premium for the bulk of the S&P 500 is therefore 2%, against a historic average of 3%, not cheap but not as expensive as some would have you believe. AI’s impact on the global economy may be exaggerated at this point but history tells you its uses will deliver another leg of economic growth. UK equities trade on closer to 13X, it may be the dullest of indexes but the FTSE 100 does have many global brand names, and with UK real interest rates still negative, does provide some merit. Regarding China, authorities will act as the lender of last resort to its economy.
Recently Michael Burry who came to fame with “The Big Short” announced to the world his firm is short again, adding refreshments to the bears’ picnic. This is not the first time since 2008 he has declared the next big crash is around the corner, 2015 being a prime example. The real question we should all grapple with is can inflation fall back to 2%, without a deep economic recession? So far the bond market says no, and the equity market thought yes but now appears more uncertain. Just don’t rule the possibility out.
So what’s my point? Stocks may continue to struggle, and yields may go higher yet, as the Fed continues to fight inflation, but there are also reasons to question Mr Burry’s very bearish viewpoint.
Looking ahead to the coming week, Fed chair Powell address an economic symposium in Kansas City. The release of Markit’s flash Purchasing Manager surveys is expected to show a decline in August. The market darling Nvidia posts its results. At least this morning equity markets are starting the week on a slightly better note.