The lack of worry is the big worry

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We are getting to that time when journalists write wrap-ups of the dying year and previews of the one about to be born — it’s take-a-step-back-and-look-at-the-big-picture season. What should Unhedged be taking a step back and looking at? Email your thoughts to me at or to Ethan at

Too-happy holidays

I’m not really sure what makes the market go up or down, which is embarrassing, because I have been thinking about it professionally, on and off, for something like 17 years now. But it does seem to help the market rise, or at least not fall, when:

  • corporate earnings are rising, ideally at an accelerating pace

  • companies are buying back a lot of their own shares

  • there is a lot of cash sloshing around the economy

  • there are still a significant minority of pessimists around who can be converted into buyers, by good news or simple capitulation

The problem with these four interrelated factors is that they are not much of a warning system. They are all true, and then none of them are, or visa-versa, at which point the market is way ahead of you. But all the same it seems worthwhile, as we barrel towards the end of the year, to look at how we are doing in each area.

S&P 500 companies have reported earnings growth of 40 per cent from a year ago, according to FactSet. This is a big number, but who cares. It is largely a result of the reopening and energy prices. What matters is how much earnings will grow next year. The current estimate for 2022 is about 8 per cent earnings growth, which is good if not great by historical standards. What worries me slightly is that the estimates place most of the growth in the back half of 2022. In the next couple of quarters, the ones analysts can see most clearly, sequential earnings growth is not expected to be all that great. A chart from FactSet’s useful earnings insight blog:

Buybacks are absolutely booming. In the third quarter, according to Howard Silverblatt of S&P Dow Jones Indices, S&P 500 companies have bought back $225bn of their own stock, beating the Q4 2018 record. The pace of buybacks has picked up for 5 quarters now. This seems to me to be a major backstop for US stocks, though, as Howard notes, stocks are so expensive that as a percentage of the market’s value the Q3 buybacks, at about .6 per cent, were well below the average of the last decade.

Liquidity, measured as balance sheet expansion at the major central banks, has been growing at a steady pace, a bit under 10 per cent. Here is a chart from cross-border capital:

This looks OK, but tapering is coming in the US and Europe. What happens then? On the other hand, China might loosen policy if the real estate market there continues to degenerate.

A lot of the money that central banks are pushing into the system is still finding its way into equities but, according to BofA, at a slightly decelerating pace in the past few weeks:

The last factor, sentiment, is the only one that really looks outright bad. Below is Citigroup’s Levkovich fear/euphoria index, which is based on a bunch of things like short interest, margin debt, and the put/call ratio. It is way up into euphoria territory, at a level that has reliably presaged bad returns in the past. To use a weary Wall Street cliché, there is no wall of worry for stocks to climb:

A particularly dreary example of this comes from Bank of America’s fund manager’s survey. Managers (unlike the punditocracy) are increasingly confident inflation is transitory:

I think I may be the last pundit in the English speaking world without a settled view on what inflation is likely to do (I found both sides of Chris Giles excellent survey equally convincing). But I am quite sure I’d be happier about the market’s prospects if I thought fund managers were more frightened about it.

Overall Thanksgiving week scorecard: market is high and expensive, but support from earnings, buybacks and liquidity seems solid (if not perfect). Sentiment levels are terrifying though.

Back to the UK

Several readers pushed back on the argument, from Friday’s letter, that UK stocks are set to be dragged down by British labour shortages. The argument was that the shortages, partly a result of Brexit, are going to become a drag on profit growth and valuations at UK companies, as they will worsen the national mix of growth versus inflation.

The objection was that the FTSE 100 is basically an index of large-cap global companies, and that local labour concerns won’t matter much to its performance.

I put this objection to Ian Harnett of Absolute Strategy Research, as it was his argument to begin with. He noted to me that UK equity returns do historically line up with UK GDP growth, despite the global character of its biggest listed companies. But that is probably down to the fact that UK GDP tracks global GDP — Britain is a small, very open economy.

But the crucial point is that ASR’s argument takes the point of view of global investors, and that the UK macroeconomic dynamics the argument describes are likely to drag on the pound. From a global investor’s point of view this will create a drag on FTSE 100 returns, unless the currency is hedged. So maybe the best reading of the argument is: hedge the pound.

The argument can also simply be recast as an argument for shorting the FTSE 250, which is a mid-cap index which generated about half its revenues domestically, against about a quarter for the FTSE 100. And that has another appeal: unlike the FTSE 100, the 250 does not look historically cheap relative to its American cousin, the S&P 400 mid-cap. On the contrary, the UK mid-caps are historically at about 20 per cent discount to US mid-caps, in price/earnings terms. Now they are close to parity, according to Bloomberg data.

One good read 

I was gripped by this New Yorker piece about forensic genealogy — a technique that is catching a lot of killers who seemed uncatchable.

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