Note Précis Nov. 20 , 2024: Many a Slip Between Cup and the Lip

Note Précis Nov.  20 , 2024: Many a Slip Between Cup and the Lip. In late 2024, equities remained in sharp upswing. A priority for countries is likely to be addressing basic costs of living populist aggrievances. It contrasts with reported inflation data favored by monetary authorities. Sharp wars and defense tensions demand increased spending. Many governments have weak mandates. Several years ago ended the seven decades of the tariff reductions crucial in boosting growth in trade. The present global milieu is one in which known and unknown pressures could flare more volatility than momentum capital markets have countenanced.

For the valuation of equities, critical is how realistic are sustained earnings growth expectations. At almost 25x P/E on consensus anticipated earnings for the S&P 500, valuation appears fulsome. It holds whether only recent years are relevant or certainly as we do in considering the full gamut of historical data. Compared to sustained 7% annual long term earnings growth, current markets appear assuming twice as much. In the latest sequence of corporate releases, from industrial/commercial high technology (like cloud computing and artificial intelligence) to the consumer (including high end luxury), companies appear circumspect on return on equity than the capital markets. For the S&P 500, operating margins peaked in mid-2021, are in decline and tariffs add to pressures.

Risk and uncertainty premiums require consideration. As causality for fracture in capital markets, fiscal challenges may be closer than central banks like to admit – IMF, OECD and BIS admonishments notwithstanding. In corporate and sovereign fixed income for a valuation base, of impact globally would be 10 year U.S. Treasury Note yields again approaching our 5% target.

With U.S. CPI inflation close to 2.6% and core at 3.3% annually as of October 2024, a data dependent Federal Reserve is likely to be more measured Many other central banks have signaled major central bank administered rate cuts. Currency and linked trade pressures should not be ignored. Across asset classes, volatility is likely to be highly elevated into 2025.

We believe that “risk on and risk off” simply related to administered rate cuts could be undone by changing circumstances. Diversification and quality of delivery appear to be crucial requirements across asset classes. In asset mix, precious metals have a role both  strategically and as an asset diversification. Even for momentum markets as took place earlier, at closer to 5% U.S. 10 year Note yield, we anticipate more focus on credit quality and prefer short duration in fixed Income.

In equities in expecting a valuation phase linked to risk premiums and earnings valuation,  quality of delivery and balance sheet strength are likely to be key across sectors and across geographies. The financials would be a central interface between interest rates and business rotation. Notwithstanding Basle III strictures, financial missteps been experienced even in becalm. Worldwide, they range not so much in derivatives as in conventional banking facets like money laundering, factoring, asset mismatch and liquidity missteps. We expect the stronger and restructuring financials to have overweight advantages.

Amid war, tariff and business challenges, elevated equity valuation appears not just sector or geography specific. To respond to market conditions of risk premiums being eschewed, we would also condense equity choices outside of the financials. We see a core rotation as being Consumption versus Production versus Inputs like raw materials and high technology items.

, More selective expenditure is likely from the advanced and emerging consumer in the present Consumption phase. Logistically, just in time manufacture and close to consumer manufacture appears. More broadly in Consumer Discretionary and in Staples, advantages appear for mixed online/brick and mortar whether in luxury or basics businesses. For broadly defined Production engineering, we see the realities as being favorable for corporate retooling, public infrastructure and defense upgrades.

In corporate reporting even by the High Technology mega favorites, actual business return seems still a fraction, albeit increasing, from the likes of cloud computing and artificial intelligence (AI). In 3% annual global GDP growth amid trade tensions, value and basics vie with strategic access including in diverse critical materials and energy. For Growth diversity, we have capped High Technology at a not low 25% to make room for strategic Materials and Enery, Healthcare and Consumer Staples. For all, political and business driven restructuring are likely to be ongoing realities.

Implicitly across asset classes and geographies, the management (corporate and government) of finance and assets, valuation and quality of delivery will likely have a greater role than fervor for momentum. In asset mix, precious metals have both a strategic mineral and diversification role. 

Our Next commentary will be in the new year.

Season’s Greetings E.o.e.  For disclosures and more depth please go to  www.subodhkumar.com