I think that I am on record somewhere for saying that I would sell everything if the 2s5 inverted. Well, it just did—by a slender margin of 2bp—and for that reason alone, I should have a view. It isn’t easy, though, to add something that hasn’t already been added by the cacophony of comments on the back of recent gyrations in U.S. bonds. If a falling tree in an empty forest doesn’t make a sound, does a yield curve inversion matter if everyone has been talking about it for a year? As it happens, the tree does make a sound, and the yield curve inversion does matter, though not for the reason that you might think. Rick Reider, CIO of the investment manager Blackrock, is a smooth operator, and he delivers the goods in a few tweets. The significance of a yield curve inversion is not about its ability to predict a recession in the U.S., or elsewhere—more about that in a bit—but about the following three points. First, the Fed has some questions to answer; second, an inverted yield is as much a statement of markets’ perception of the Fed’s neutral/terminal rate as it is about its ability to forewarn about a recession, and third; bonds are finally offering a bit of protection for balanced portfolios. This week, I’ll go through each of these points in turn.
Read MoreI 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 MoreUnfortunately, the stand-out move in markets since my last report—the crash in oil prices—is one on which I have little to say, let alone expertise. I didn’t see it coming, and I am not exactly sure why it happened. That said, I am not here to make excuses, so I’ll try to connect the dots as well as I can. A sudden fear of over-supply due to a shift in OPEC policy doesn’t seem to cut it as an explanation. I am more inclined to buy the idea of linking it with the jump natural gas prices, deeming it an erstwhile winning spread-trade gone wrong, at least in part. Pierre Andurand’s name has been mentioned too, which certifies that this has been a real rout in the oil market. Mr. Andurand’s $1B commodities fund reportedly shed a cool 20.9% last month. Whatever the causes of the swoon in oil, it serves as a decent entry the broader market discourse. I am sympathetic to the argument by Cameron Crise, a strategist with Bloomberg, that “Recent energy-price mayhem is just the latest sign that something about these markets looks broken.” Cameron goes on: “The presumption of a continuous liquidity spectrum is clearly an errant one.” Most readers of these pages will have plenty of recent examples that fit this picture, so I’ll jump straight to the grand conclusion.
Read MoreIf you are an equity investor with time to read this, I reckon that I should have the decency to cut straight to the point. Based on macro liquidity indicators, I see a convincing case for a short-term bounce in global equities into year-end, before—unfortunately—further weakness in Q1. The main argument is summarized in the two charts on the following page. The first compares momentum—the 2nd derivative of y/y growth—in global equities and global real M1. I am working under the assumption that the year-over-year rate in the global stock index will decline gradually to -10% by the end of March. Adding back into the price points to just under 6% upside between now and the end of December, before a nasty 11% drawdown in the first quarter. This story is supported by the idea that higher yields and rising oil prices are now a significant challenge to multiples, especially in the U.S. Abee makes a similar point over at Macro Man, with the ominous addendum that it’ll probably get worse if growth in earnings falter, which they are liable to do, eventually. The argument for a short-term bounce is straightforward. At the time of writing, the global equity benchmark is down nearly 10% on the month in October, and about 5% for the year. I never thought that this would be a particularly good year for equities, but this seems like an excessive reaction, after all.
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