Equities have wobbled a bit at the start of the month, but unless they lose the plot in coming weeks, it is fair to say that Q1 will be everything that Q4 wasn’t; decent and calm. Indeed, the finer details reveal an even more striking dichotomy with the calamity that culminated in the rout at the end of last year. Between June—when the PE multiple peaked at just under 21—and the low for the S&P 500 in the final weak of December, EPS rose by 13%, but the index fell by 10%. In other words, the multiple crashed, a story which was repeated across almost all key DM and EM indices. By contrast, the story so far in Q1 is the exact opposite. By my calculation, trailing EPS for the S&P 500 and MSCI World are down 0.5% and 2.1% year-to-date, respectively, but both indices have rallied smartly. This can only mean one thing; multiples have expanded, and they have indeed, by about 14% in both cases since the end of December. I am confident that the tug-of-war between multiple expansion and deteriorating earnings will determine the fate of many equity investors in 2019.Read More
I am short on time this weekend, so I am doubling down on the story I told last week, with two more charts and some additional comments. The first chart updates picture of the startling spread between price change in S&P 500 and its multiple. As of last week, the U.S. large cap equity index was down 0.2% on the year, but trailing earnings were rising just under 22%. The only way to square these two headlines is to note that the P/E multiple has crashed, from a high of nearly 23 in January to 18 today. The silver lining is easy to spot. The market is now about 20% cheaper than it was at the start of the year, a significant re-rating.
The flip side is that paying 18 times earnings for the S&P 500 is not egregiously cheap. If growth in earnings roll over, a further decline in multiples would, at best, lead to stagnation; at worst, it would drive prices much lower. That’s certainly a significant risk if you consider that this year’s impressive jump in earnings, at least in part, have been driven by tax cuts, which won’t be repeated next year. It gets even worse if we start to change the assumptions around share buybacks, another important support for earnings growth via its denominator-reducing effect on the share count in the EPS calculation.Read More
I said my peace on global growth and EM currency crises last week, so I won’t belabour those here. I am struggling, however, to square the circle on the dollar and U.S. bonds. The story for the greenback appears simple; interest rate differentials suddenly matter again. The Fed is on the move, but expectations for tighter monetary policy elsewhere has been pushed back, especially in the U.K. and in the Eurozone. Even in Japan, few believe that the BOJ will do anything, anytime soon. HSBC’s FX Chief, David Bloom, does an admirable job explaining this in a recent segment on Bloomberg TV. By this account, the rout in EM is as much about a shift in G4 central bank expectations as it is about the lagged effect of higher short-term rates in the U.S. and structurally-vulnerable balance sheets. As long as European and Asian central banks drag their feet, and the Fed keeps going, the dollar will continue to rally; its simple. The problem with this story is that it assumes that the combination of a hawkish Fed and higher U.S. bond yields persists. Almost all my models are telling me to fade this story. For starters, the curve continues to lurk as the proverbial elephant in the room.Read More
I have trampled around in the same weeds recently, so I will keep it short this week. Equities are doing what they’re supposed to, trying to complete a V-shaped recovery from the swoon earlier this month. Last week was a corker, even for the portfolio, which benefitted from solid earnings reports. Bloomberg’s Joe Weisenthal had me one-on-one on Monday, where I duly warned that the S&P 500 remained overvalued relative to other asset classes. Even Gartman couldn’t have done it better. On this occasion, though, I am happy to double down. A V-shaped rebound to a new bull run looks like wishful thinking to me. Equities are the least of macro investors’ problems, though. The puzzle of the day remains the link between rising U.S. yields, a firming cyclical outlook and a falling dollar. In my last post, I asked the question of whether foreign savings would come to aid of a U.S. economy at full employment—with a record low savings rate—about to be jolted by fiscal stimulus. Open macroeconomics suggest that such an economy should open up a large external deficit, and Japan and Europe have the savings to make it happen. Alternatively I suggested that perhaps the rest of the world doesn’t fancy financing excess spending and investment in the U.S.Read More