Note Précis January 24,2019: Our take from the parable of Humpty Dumpty is that breaking something is a lot easier than was putting it together, let alone patching it up after breakage. Students of the political economy need to recognize the United States and British leadership from Bretton Woods in 1944 and many subsequent agreements versus the current fissures in both lands. In contrast are the German/French agreement just now in historically fraught Aachen and the many Asian led initiatives, including the TPP.
Further, students of the capital markets need to move beyond rationalizing every momentum move. Recalling our past experiences like the growth valuation collapse of the nifty-fifty in the 1970s, the valuation compressions of the 1980s to build risk premiums, the TMT collapse into 2000, the credit debacle into 2008 and not least the hubris excess into 1987 and many before our time, we look in askance at some considerations placing Q4/2018 as being the equivalent of a bear market cycle. Instead, investors should contemplate as institutions like the IMF and the BIS have suggested, the risks of excess leverage. Also relevant and which many institutions shy away from, whether excessive quantitative ease has so distorted capital market valuation as to impair its role of efficiently allocating capital.
Late January has become a time in which many developments occur. It includes global new year meetings like those at Davos and corporate releases. In 2019, to be added for the capital markets are the political issues of fissure such as in the United States and Britain, of trade tensions and tariffs. As well as within the markets are issues of valuation and risk thereof assumed. Ingesting the lessons of Humpty Dumpty means to us that investors need to move beyond assuming at infinitum that massive quantitative ease equates with expansionary markets. There remains an inherent contradiction between assuming economic growth would be weak enough to result in continued massive quantitative ease and yet have companies also possessing the wherewithal to deliver long term double digit annual earnings growth.
We believe that 16x P/E on long term 7% annual earnings growth remains an important benchmark hurdle for the S&P 500. We suspect that the predisposition since 2009 will not last, of overwhelmingly focus on the beating of most recent consensus. The latest twist in financial engineering and investment thereof of funding leveraged loans accompanied by reduced covenants appears to be dependent on more of the same of the current cycle’s obsession with central bank accommodation. The impact of leveraged ETFs is also yet to be tested over a full cycle. Instead, we expect focus to expand on the quality of delivery being incorporated in reported results for countries and companies alike.
StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.