Tag Archives: uncertainty

Goldilocks Lives

With the S&P500 off its September high and US 10 year yields well over 3% back in October, its crazy to think that just 6 months later the 10-year yield is currently around 2.6% and the S&P500 has just hit new highs. What was all the fuss about! A return to a steady US GDP non-inflationary growth as per the Q1 figures and with Q1 earnings coming in ahead of reduced expectations (with approx. half of the S&P500 reported), one could be tempted to think we have returned to the good old Goldilocks days. My predictions (here) of a rebound off the December lows followed by more volatility in Q1 were well wide of the mark with volatility across major asset classes eerily low as the market hits new highs. My record of been wide of the mark has at least been consistent with this post from January last year calling a premature ending to Goldilocks!

Some commentators are bullish on more upside for the market on the improved economic and earnings figures and cite comparisons to similar 20% drops and recoveries in 1998 and 2011. The graph below shows the comparisons, with 2 other 20% drops (although 1957 and 1990 were during recessions).

click to enlarge

As to what happens next, I have no idea. Some say at 17 times forward earnings; the market is not too expensive, and a wall of money will fuel this FOMO (fear of missing out) rally. Although the positive narrative from Q1 earnings will likely dictate short term trends, the market just feels like it has gotten ahead of itself to me and I feel comfortable taking some money off the table. As the graph below of monthly moves greater than +/- 3% shows, volatility is never that far away.

click to enlarge

A return to economic and earnings growth also raises the question of how long the Fed can remain ultra-accommodative. The arguments on raising rates and debts levels are all very déjà vu! For the moment however, unless the China trade talks fall apart, all looks surprisingly rosy.

There are always concerns. Bank of America recently highlighted that over the past five years, US firms have paid out $3.3 trillion in dividends and bought back $2.7 trillion of their own shares ($800 billion in 2018 alone) whilst taking on $2.5 trillion of new debt. The buybacks are responsible for 30% of earnings growth according to Bank of America (20% in 2018). The need to pay down this debt was a focus for many firms in the stock market rout. Bank of America predict further upside in equities to the summer before a pullback in Q3. The ever-excellent John Authers (ex-FT columnist now with Bloomberg) had an insightful article on corporate debt in March.

According to a recent report from Euler Hermes, the non-bank leveraged loan market is flattering the overall US corporate debt profile and corporate spreads are likely under estimating risk. This report from Moodys suggests that high leverage is offset by ample coverage of net interest expense. In this report, S&P estimate that “the proportion of companies having aggressive or highly leveraged financial risk has risen slightly to 61% (compared to 2009)”. Regulators also remain concerned about debt levels, particularly leveraged loans as per this recent report. The size of the leveraged loan market globally is estimated around $1.5 trillion, with the Bank of England estimates shown below.

click to enlarge

According to Ron Temple of Lazard Asset Management the “deterioration in underwriting standards for leveraged loans is increasingly worrisome” and the graph below shows the increased leverage in the market which combined with lax terms (approx. 80% are covenant lite loans) are a red flag in the event of any downturn.

click to enlarge

The buoyant private equity market is a testament to the joys of leverage, with recent PE raisings hitting records and an estimated $1.3 trillion of undeployed capital as of March. In this recent FT article, Jonathan Lavine of Bain Capital warned that private equity groups are taking on too much debt in the competition to win deals (the Bain 2019 market report is well worth a read).

Still, these are all things to worry about in times of stress. As of now, let’s enjoy Goldilocks return and keep dancing. Carefully mind you, it is late and we don’t want to wake those bears.


As is now customary ahead of Davos week, the latest World Economic Forum report on global risks was released and the usual graphic of the top 5 global risks in terms of likelihood and impact are reproduced below. Environmental risks and technology risks again dominate the likelihood list which is indicative of the current consensus. As this post highlights, the likelihood of irreversible climate change within the next 10 to 20 years is the short, medium and long-term issue of our times.

Although the report does state that “geopolitical and geo-economic tensions are rising among the world’s major powers” and that these “tensions represent the most urgent global risks at present”, I was somewhat surprised to see that geopolitical risk did not make the top 5 likelihood list this year. Despite the current market (wishful in my view) thinking of a kick the can down the road fudge outcome, Brexit in 2019 may result in a constitutional crisis in the UK or the possibility of a large portion of the population being alienated by a possible rushed outcome this Spring (e.g. hard Brexit or permanent custom union). His Orangeness and his ability to flame division, whether internally in the US after a bad Mueller report or against China to deflect from his pitiful negotiating style, are ever present possibilities for 2019 (if not hopefully remote ones). Although maybe somewhat alarmist, I can’t but help worry that his reign may end with some form of violent turmoil, he will not go quietly!

As an aside, the wonderful TV show “Brexit: The Uncivil War” from the UK’s Channel 4, which I think is on Netflix now, does raise the issue of how democracies will operate in a world where all sides can use technology to manipulate a (potentially decisive) disengaged minority to the political extremes. If the long-term success of democracy is dependent upon compromise, then we may be in trouble. Pundits say the implications of Brexit politics is a break from the traditional left/right or conservative/liberal divide, into a much more complex mixture of differing tribes. In fact, I would highly recommend this video from Dominic Cummings, the main subject of the show, who ably explains the parameters of the new political landscape (if you don’t have the time to watch it all, watch a few minutes after the 15-minute mark on how they did it).

click to enlarge

One other item that caught my attention in the WEF report, in section 6 called Open Secrets, was the assertion that when “the huge resources being devoted to quantum research lead to large-scale quantum computing, many of the tools that form the basis of current digital cryptography will be rendered obsolete”. The article further asserts that “public key algorithms, in particular, will be effortlessly crackable” and, under certain scenarios, “a collapse of cryptography would take with it much of the scaffolding of digital life”. Do I hear a new arms race approaching? The report predicts “as the prospect of quantum code-breaking looms closer, a transition to new alternatives—such as lattice-based and hashbased cryptography—will gather pace” although “some may even revert to low-tech solutions, taking sensitive information offline and relying on in-person exchanges”. Imagine having to rely on people meeting other people to get things done……..unthinkable!

A naughty or nice 2019?

They say if you keep making the same prediction, at some stage it will come true. Well, my 2018 post a year ago on the return of volatility eventually proved prescient (I made the same prediction for 2017!). Besides the equity markets (multiple posts with the latest one here), the non-company specific topics covered in this blog in 2018 ranged from the telecom sector (here), insurance (here, here, and here), climate change (here and here), to my own favourite posts on artificial intelligence (here, here and here).

The most popular post (by far thanks to a repost by InsuranceLinked)) this year was on the Lloyds’ of London market (here) and I again undertake to try to post more on insurance specific topics in 2019. My company specific posts in 2018 centered on CenturyLink (CTL), Apple (AAPL), PaddyPowerBetfair (PPB.L), and Nvidia (NVDA). Given that I am now on the side-lines on all these names, except CTL, until their operating results justify my estimate of fair value and the market direction is clearer, I hope to widen the range of firms I will post on in 2019, time permitting. Although this blog is primarily a means of trying to clarify my own thoughts on various topics by means of a public diary of sorts, it is gratifying to see that I got the highest number of views and visitors in 2018. I am most grateful to you, dear reader, for that.

In terms of predictions for the 2019 equity markets, the graph below shows the latest targets from market analysts. Given the volatility in Q4 2018, it is unsurprising that the range of estimates for 2019 is wider than previously. At the beginning of 2018, the consensus EPS estimate for the S&P500 was $146.00 with an average multiple just below 20. Current 2018 estimates of $157.00 resulted in a multiple of 16 for the year end S&P500 number. The drop from 20 to 16 illustrates the level of uncertainty in the current market

click to enlarge

For 2019, the consensus EPS estimate is (currently) $171.00 with an average 2019 year-end target of 2,900 implying a 17 multiple. Given that this EPS estimate of 9% growth includes sectors such as energy with an assumed healthy 10% EPS growth projection despite the oil price drop, it’s probable that this EPS estimate will come down during the upcoming earnings season as firms err on the conservative side for their 2019 projections.

The bears point to building pressures on top-line growth and on record profit margins. The golden boy of the moment, Michael Wilson of Morgan Stanley, calls the current 2019 EPS estimates “lofty”. The bulls point to the newly established (as of last Friday) Powell Put and the likely resolution of the US-China trade spat (because both sides need it). I am still dubious on a significant or timely relaxation of global quantitative tightening and don’t feel particularly inclined to bet money on the Orange One’s negotiating prowess with China. My guess is the Chinese will give enough for a fudge but not enough to satisfy Trump’s narcissistic need (and political need?) for a visible outright victory. The NAFTA negotiations and his stance on the Wall show outcomes bear little relation to the rhetoric of the man. These issues will be the story of 2019. Plus Brexit of course (or as I suspect the lack thereof).

Until we get further insight from the Q4 earnings calls, my current base assumption of 4% EPS growth to $164 with a multiple of 15 to 16 implies the S&P500 will be range bound around current levels of 2,400 – 2,600. Hopefully with less big moves up or down!

Historically, a non-recessionary bear market lasts on average 7 months according to Ed Clissold of Ned Davis Research (see their 2019 report here). According to Bank of America, since 1950 the S&P 500 has endured 11 retreats of 12% or more in prolonged bull markets with these corrections lasting 8 months on average. The exhibit below suggests that such corrections only take 5 months to recover peak to trough.

click to enlarge

To get a feel for the possible direction of the S&P500 over 2019, I looked at the historical path of the index over 300 trading days after a peak for 4 non-recessionary and 4 recessionary periods (remember recessions are usually declared after they have begun), as below.

Note: These graphs have been subsequently updated for the S&P500 close to the 18th January 2019. 

click to enlarges&p500 q42018 drop compared to 4 nonrecession drops in 1962 1987 1998 & 2015 updated


click to enlarges&p500 q42018 drop compared to 4 recession drops in 1957 1974 1990 & 2000 updated


I will leave it to you, dear reader, to decide which path represents the most likely one for 2019. It is interesting that the 1957 track most closely matches the moves to date  (Ed: as per the date of the post, obviously not after that date!) but history rarely exactly rhymes. I have no idea whether 2019 will be naughty or nice for equity investors. I can predict with 100% certainty that it will not be dull….

Given that Brightwater’s pure Alpha fund has reportingly returned an impressive 14.6% for 2018 net of fees, I will leave the last word to Ray Dalio, who has featured regularly in this blog in 2018, as per his recent article (which I highly recommend):

Typically at this phase of the short-term debt cycle (which is where we are now), the prices of the hottest stocks and other equity-like assets that do well when growth is strong (e.g., private equity and real estate) decline and corporate credit spreads and credit risks start to rise. Typically, that happens in the areas that have had the biggest debt growth, especially if that happens in the largely unregulated shadow banking system (i.e., the non-bank lending system). In the last cycle, it was in the mortgage debt market. In this cycle, it has been in corporate and government debt markets.

When the cracks start to appear, both those problems that one can anticipate and those that one can’t start to appear, so it is especially important to identify them quickly and stay one step ahead of them.

So, it appears to me that we are in the late stages of both the short-term and long-term debt cycles. In other words, a) we are in the late-cycle phase of the short-term debt cycle when profit and earnings growth are still strong and the tightening of credit is causing asset prices to decline, and b) we are in the late-cycle phase of the long-term debt cycle when asset prices and economies are sensitive to tightenings and when central banks don’t have much power to ease credit.

A very happy and healthy 2019 to all.

Enervating Market

Wow, what a December this has been in the equity markets! Not a buyer in sight as we (effectively given the Christmas break) end the year at the S&P500 close today of 2,417. This really is a market to stay well away from. I suspect Q1 2019 will again be volatile until we get into earnings season and get a taste of the sector 2019 EPS projections (a minor relief rally from institutional funds allocating capital followed by more programme selling is my guess).

This recent post postulated that with small single digit EPS growth for 2019 and 2020, a slowing but non-recession scenario, a range of 2,500 to 2,300 on the S&P500. Well, we’re bang in that range now!! And the consensus is for more downside with the probability of a recession beginning next year raising by the day. Not even dovish statements today from John Williams of the New York Fed could tempt the buyers out of hibernation. The prospect of the demise of the Fed put has freaked the market out this week. My crude calculations estimate that a slow drop in operating EPS over 2019 of 6%, likely in a mild recession scenario, could result in the S&P500 testing 2,000.

I have been bearish on this market for several years (here, here and here are just recent examples) and although the majority of my assets have been in cash throughout 2018, the graph below from BoA Merrill Lynch, sends a shiver down my spine. As with most people, my equity positions have been hammered. According to BoA ML, the last time there was positive cash and negative equity, credit, and government returns in the same year was 1969. To plagiarize the old investing adage, it would take some monkey to call a bottom on this equity market any time soon.

Click to Enlarge

The outlook for 2019 is highly uncertain at the current point in time, nobody really knows how it will pan out and I’ll leave the musing over that topic to future posts. As this post in January highlighted, I do think quantitative tightening and the great unwinding of Central Bank easing experimentation is having some nasty unintended consequences.

At this time, I do find it insightful to look at recent movements in a historical context. If you look at the number of months with moves greater than or equal to +/-1% in the S&P500, the comparison between the decades is as below. The number of such moves are surprisingly consistent across the decades.

Click to Enlarge

If we assume that the 1970s and the 2000’s were extraordinary decades with the oil and financial crises respectively, then there could be more up months than down months due in the remainder of this decade for it to look more like the 1980s or the 1990s. A pretty flimsy analysis admittedly!

Continuing the theme of trying to end the year on a positive note, if we look at the historical months with moves of +/-5%, as below, it could be argued that the recent volatility is healthy as extended periods of reduced volatility prior to the dotcom bubble and the financial crisis didn’t end well!!

Click to Enlarge

That’s a happier note to end on (albeit rather pangloss).

A very happy and healthy Christmas to all who have spent any time reading my musings this year.

Bye-bye buy the dip

As my previous post illustrated, I got caught up with the notion that the fall in the equity market of late was an opportunity to buy into some names in the expectation that we’d go higher into year end. It’s clear that the classic “buy the dip” strategy that has worked so well in recent years, well, doesn’t work anymore. The graph below, from a report by equity strategist Michael Wilson of Morgan Stanley, has been widely cited to illustrate the failure of the strategy in 2018.

click to enlarge

Wilson commented that “such market behaviour is rare and in the past has coincided with official bear markets (20 percent declines), recessions, or both.” There is much discussion amongst commentators about whether we are entering, or indeed have entered, a bear market. I like the simplicity of the argument by Peter Oppenheimer, another equity strategist this time at Goldman Sachs. Oppenheimer argues that a decline in corporate profits in 2019 implies a recession in the US and as a recession is unlikely in 2019, he expects corporate profits to continue to grow, albeit at a much-reduced pace.

As pointed out by Wilson, we will not know the answer about where corporate profits are going until firms report Q4 and guide for 2019. He did also say that equity analysts are always slow off the mark as they wait for firms to reluctantly report on bad news. The after the fact downgrades on NVDA are testament to that! With some commentators calling the bottom around 2,550 to 2,600 on the S&P500, it looks unlikely that there will be any major upside in the market until there is more clarity on Fed policy and the trade issues with China.

If the market moving up depends upon Fed Chairman Powell indicating a policy change to “one and wait” or for a breakthrough at the G20 on trade, then I think we’ll go down further or, at best, sideways. If there is some modest indicator that the pace of interest rate rises in 2019 will be data dependent from Powell and the G20 meeting results in a short-term cease-fire between the US and China, then markets could find a bottom and stabilize. Whatever about the likelihood of the Fed rescuing the market (unlikely in my opinion), I fear that any meaningful relaxation in US-China tensions is against the play-book of the Orange One in the White House. The rhetoric from side-kick Pence at the weekend with language indicating China was leading other Asian countries into debt bondage does not bode well for next week’s G20 summit.

On China, I really like Ray Dalio’s explanation of the fundamental difference between the Chinese and US system (here is just one example of his latest thoughts), being a top down versus a bottom up approach. As Dalio explained it, the Chinese place an importance on family and paternal direction as opposed to the US adoration of the individual above all else. Unfortunately, I doubt that the current US leadership has the intellect to nuance a workable resolution between these two philosophies.

Following on from the analysis in this post on peak quarterly earnings, the current market narrative is that the EPS estimates for 2019 and 2020 will come down over the coming months. Currently S&P is showing a 11% projected increase for 2019 operating EPS for the S&P500 (13% on a reported EPS basis). The current market jitters indicate the market view those figures as unrealistic. Oppenheimer indicated that Goldman Sachs is currently thinking about a 6% and a 4% growth in EPS for 2019 and 2020 respectively is more realistic. Wilson indicted Morgan Stanley are projecting EPS growth for 2019 in the low single digits.

Given that estimates usually increase over time in the good years and decease in the bad years, I am going to assume a 3% and 1% increase in operating EPS for 2019 and 2020 respectively in this no recession but slowing growth scenario. Given that forward multiples would also decline in such a slowing environment (I have assumed to a modest 14), I estimate year-end targets for the S&P500 for 2019 and 2020 of 2,500 and 2,300 respectively, a decline of 6% and 13% respectively over the S&P500 today! The graph below shows the scenario as described.

click to enlarge

Economies generally don’t have slow gentle soft landings, it’s nearly always turbulent. Just look at the chart above to see how improbable the gentle scenario is compared to history. We need a major boast, such as a comprehensive resolution of the US-China trade issue, to maintain the bull market. Otherwise, I suspect the great EPS growth party is over.

Interestingly, Morgan Stanley also highlighted the headwind of quantitative tightening, as per the graph below, on the current market fall. I last discussed this issue in this post in January.

click to enlarge

No more buy the dip for a while yet I fear…….