This article was last updated on February 20, 2024
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In Pushing Ahead Can Lie Market Folies
Note Feb 16, 2024: In Pushing Ahead Can Lie Market Folies – Capital markets folies in pushing the can ahead should be of concern. Data is reflected in steady/high rates for longer from the Federal Reserve, Bank of Canada, Bank of England and even the ECB despite its national spectrums. While China battles asset deflation and Japan prevaricates, many emerging countries have stoked currency risk. Momentum versus valuation imbalances extenuate the already flaring volatility.
Assuming financial lax did not lead to stability in the ancient and modern worlds. Fiscal deficits appear globally large. Elections loom and action is plodding. Meanwhile, vicious wars rage as do shadow jousts from the Arctic to Europe to the Indian and Pacific Ocean trading channels. As global template warning is the Congressional Budget Office report projecting the U.S. federal deficit increasing 50% by 2034, on interest and program costs. Also relevant today as global template is the shelved Simpson-Bowles Commission deficit reduction plan report. In the 1980s/ early 90s, strong central bankers stood up to politics and inflation while advanced and previously command economies developed monetary and fiscal restructuring. Restructuring included corporate and state sectors, led to reduced deficits and higher prosperity by the mid-1990s. Since then, the administrative and capital market emphasis for succor appears from monetarist machinations. Delayed focus on basics would elevaterisk premiums and chronic volatility.
In a replay of 2009 intto 2021 of momentum behavior, early 2024 contained a massive global upswing in fixed income, in equities and lessened pressure on exchange rates of major advanced countries. The capital markets have appeared to assume early administered rate cuts and via a rally in junk bonds, to underscore a risk view of solace from central bank puts. As credit analysis flows through fixed income and currency markets of central banks game play of higher for longer, risk premiums have likely more to rise.
On cyclically adjusted or even consensus earnings expectations, equity market P/E multiples are hardly low. At 20x P/E levels, the S&P 500 likely has expectations of long term sustained growth of 12% and for its coterie of equities leading this rally, expectations of 20% earnings growth per year. At an expansion phase, expectations being reduced and then beating consensus is less robust than earnings being revised upwards in cycle recovery. Further, crude oil prices, logistics and shipping costs appear as bifurcation drags to operations and end users.
Potential for equity valuation contraction exists from a risk premium around 200 basis points on top of a risk free rate of either 3 month T-Bills or slightly less on 10 year T Notes. In market cycles as seen in the nifty fifty in the 1960s, energy commodities in the 1970s, TMT in the late 1990s and salacious credit into 2007, it is not unusual for favored coteries to exert extreme momentum followed by rebalance. We would cap overall Information Technology as well as diversifying within and without.
The first six weeks of 2024 have had plentiful monetary and fiscal markers. Capital markets folies in pushing ahead the can further down the road should be of concern. By stoking exuberance , momentum versus valuation imbalances are likely to extenuate for longer, the already flaring volatility. In contrast to market euphoria about early administered rate cuts, data such as employment and inflation as well as commentary from the Federal Reserve and the Bank of Canada emphasize steady/high rates for longer. The same can be said about the post meeting stance of the Bank of England. The European divide appears again with stressed countries like Italy having monetary authorities musing about early cuts while conservatives like Germany emphasize caution and France appears at mid-point. Overall, the ECB appears closer to no ease for longer. Japan remains an enigma on monetary policy amid recession. China appears battling asset deflation. India appears on course to curbing inflation. Elsewhere appears crisis in emerging countries such as in Argentina to Turkey that is likely to enforce higher rates to stabilize currency markets. These concerns risk expanding in the guise of momentum excess.
In the ancient and modern worlds, assuming financial lax did not lead to stability or prosperity. There appear few exceptions such as India presenting deficit reductions even in a pre-election budget. Current fiscal deficits appear globally large and need attention. However, elections loom and action is plodding. Illustrative as a global template of financial squeeze potential is the just released and non-partisan U.S. Congressional Budget Office report projecting the U.S. federal deficit as already at $1.7 trillion and absent policy change, potentially reaching $2.3 trillion by 2034 on interest and program costs. Relevant as global template today as well is the shelved 2010 and revised in 2013 the Simpson-Bowles Commission deficit reduction plan report. It notably was issued recognizing existing credit crisis. The current policy contrast with the 1980s/early 1990s cycle of restructuring could also not be greater. In the 1980s/early 90s, admittedly under the aegis of strong central bankers were stances willing to stand up to politics and to respond to the scourges of inflation. Advanced and previously command economies developed monetary and fiscal restructuring. It extended into the corporate and state sectors including privatization to improve efficiencies. By the mid-1990s, it led to reduced deficits and higher prosperity. Since then and into 2024, the administrative and capital market emphasis appears to be on succor from monetarist machinations. We believe that more focus is needed on a return to basics. Absent which and kicking the can down the road would mean elevated risk premiums and volatility likely to be chronic.
In the realm of the political economy and with belated recognition of urgency, many global structures now appear frayed. They range from trade to health to climate to political norm understandings. Renewed structures after world war did buttress prosperity. Today, elections loom in the U.S., across Europe and Asia. Several governments appear to be in coalitions of convenience and unstable, including in Latin America. In election heavy 2024 just how fraught internal politics have become can be seen in a supplemental defense and aid appropriation of 1.5% of the unpassed U.S. budget has remains stuck despite several sessions including an overnight marathon. In Europe, a swift budget appropriation was needed while on leader went for a coffee. In the crucial West Asia/Middle East, war has become ever more vicious in Gaza. The fragility of shipping and logistics have been demonstrated in the Red Sea/Indian Ocean via the asymmetrical use of drone warfare. Actual war continues in Ukraine. Tensions in the Indo Pacific have been joined overtly by those across the Arctic. We believe that capital markets have become overly monetarist focused and require rebalance including scrutiny of quality issues like operations delivery and financial risk premiums.
In what appears to be a replay of market momentum behavior from 2009 to 2021, the first half of Q1/2024 has contained a massive global upswing in fixed income, in equities and in lessened pressure on exchange rates of major advanced countries versus the U.S. dollar. Unlike convergence from 2009 onwards, in early 2024, the capital markets have appeared to take in a view of early administered rate cuts as being imminent . It has resulted in and positioning contrary to the pronouncements of several of the major central banks. In effect, by extending a rally into junk bonds, the capital markets have appeared to also take in a risk view of solace again coming from central bank puts. As credit analysis is likely to need to flowthrough fixed income and currency markets. As seen in the 1980s/early 1990s and not necessarily in size or type, central banks are likely incorporating a game play of higher for longer administered rates. It would mean that risk premiums have likely more to rise.
On cyclically adjusted earnings or even consensus earnings expectations, equity market P/E multiples are hardly low. In equities in early 2024, we believe that at 20x P/E levels, the S&P 500 has incorporated long term sustained earnings growth of 12% per year. For the coterie of equities that have led this rally, their 30+ P/E would require 20% earnings growth per year to be sustained. Unlike the recovery from the earnings low of 2009, a 12-20% sustained annual earnings growth range would be on top of that are what already expansion level earnings. Earnings expectations being reduced and then celebrated as beating consensus are less than robust. It contrasts to earlier in a cycle recovery of earnings coming in above expectations that had already been revised upwards. Further, crude oil prices, logistics and shipping costs appear as broader drags to company operation profitability. End users like consumers appear already hard pressed even for basic necessities in advanced and emerging regions alike. Bifurcation risks loom between and inside corporations.
There exists potential for equity valuation contraction from lacing a risk premium of at least 200 basis points on top of a risk free rate of either 3 month T-Bills or even slightly less on 10 year T Notes. As seen about the nifty fifty in the 1960s, energy commodities in the 1970s, TMT in the late 1990s and salacious credit into 2007, in market cycles, it is not unusual for favored coteries to exert extreme momentum to be then followed by rebalance. We would cap overall Information Technology as well as diversifying within and without.