Updated 18 June 2022.
Global Equity Valuations – possibly more downside given Fed Fund rate expectations
From the 20x P/E at start-2022, personally felt it was going to be hard to sustain into 2022 because:
- Global monetary tightening
- Fading fiscal stimulus packages
- Raw material / wage inflation eating into corporate margins, while demand hindered by price inflation.
- China looking like it’s more accommodative of slower growth (as long as it’s more sustainable and positive to the society)
- Recent Fed hawkishness (market is pricing in over fourteen 0.25% equivalent rate hikes for 2022)
While equity valuations (particularly ex-US) are currently below historical average, there’s still about 10% downside to earnings multiples should markets revert to 4Q2018 valuations (back when Fed Funds rate peaked at 2.5% – and keep in mind that the Fed Funds rate for the current cycle is expected to surpass this).
Another source of downside risk stems from EPS estimates for 2022/23 which seem overly optimistic, and have yet to be meaningfully revised down by analysts.
Global equity index drawdown of 23% still leaves room for further downside should energy and food-related supply chain disruptions start to impact corporate earnings and erode consumer confidence. Also worth noting that in past rate hike and inflation cycles, S&P 500 tends to perform weakly i) till 3 months post the first rate hike, ii) till inflation peaked
US Treasury yields have woken up
Fed balance sheet run to commence in June 2022 at a pace of US$47.5B/mth, and doubling to $95B/mth from September 2022 onwards.
For context, it was two years from the first Fed rate hike in 2015 before the commencement of a balance sheet run off in 2017 (compared to 3 months this time around).
US IG and High Yield Bonds still look somewhat expensive, while Asian High Yield Bonds look decently attractive
Global High Yield Bonds credit spreads have started to widen (as loose monetary policy begins to normalize), leading to popular US High Yield Bonds ETFs (JNK, HYG) to decline by 14% year-to-date.
US investment grade bond credit spreads have also started to widen from cycle troughs. Popular US IG bond ETFs like LQD are down 17% year-to-date, faring worse than HY bond ETFs due to the longer duration.
Asian USD High Yield Bonds look decently attractive within the fixed income space. A lot of it is due to concerns around the tightening regulatory impact on China’s Property Sector, which forms a large part of the Asian High Yield market.
With the view that the China government will not allow a systemic collapse of the property sector given its importance in achieving “common prosperity”, current entry levels to Asian High Yield look very appealing. That said, broad-based policy support has been slower than expected, and we are down about 19% (after dollar cost averaging into the sector since Sep-2021).
Mixed feelings on Gold prices
Heading into 2022, tightening Central Bank monetary policies (rate hikes / tapering of asset purchases) look to be increasing headwinds for gold. While inflationary concerns and safe-haven demand look to be tailwinds.
S&P 500 Equity Volatility
Vix (a measure of US stock volatility) is also known as a “fear index”. Personally think it’s worth exploring selling put options on equity indices, with the recent vol spike.
Source: Bloomberg, retrieved as of 18 June 2022.