I am writing these lines to try to “lift the veil,” that is, remove the veil of euphoria that’s been hanging over the stock markets since April, to bring a bit of realism and to better illustrate why portfolios, for example, have been in protective mode for a few weeks now.
As you know, Warren Buffet’s rule no. 1 is to not lose, due to the asymmetry of results. If a portfolio loses 30%, to return to par it won’t have to gain 30%, but rather 42.86%.
So learning not to lose, or at least to have very limited drawdowns, is of fundamental importance.
We’re showing some charts from leading analyst firms, such as the earnings forecast for the next few quarters for the entire SP500 index, compared to the earnings forecast for the MAG7, and also for the remaining 493 stocks that make up the index.
We see how earnings growth is declining in all three cases, and this will somehow impact the quarterly results and subsequent company guidance, and ultimately, the value of the SP500, which today, let’s remember, at 6,400 points leads to a multiple of 24x, a valuation similar to October 2020 and December 2021, i.e., moments of extreme valuation and euphoria in the stock markets. This valuation level requires absolute caution, especially considering that the historical average multiple of the SP500 is 16x. If anything, but we don’t believe it will happen, the US index were to reach 16x earnings again, this would mean an index around 3,800 points, just to give you an idea of current overvaluation.
Could this forecast of a decline in earnings be due to the introduction of tariffs? Let’s look at the level of US tariffs over the years and compare them with the current one. The high level, which in this chart stops at 10%, could reach 15%. But would this be a one-off event, or will it become the new stable level of tariffs?
The situation is confusing, and there are countless reasons for this widespread confusion. Evidence of this confusion is also provided by the survey that Bank of America periodically conducts of fund managers, and in this case we see a clear and unusual divergence. That is, most fund managers expect a new surge in inflation, but the majority still do not associate this new surge with the risk of a rate hike.
But the real problem concerns debt refinancing. Perhaps this explains why fund managers do not consider the possibility of a rate hike even in the presence of rising inflation, and this part of the survey clearly shows this. Fund managers are expecting one of two interventions: either a new QE or a real intervention on the curve, the Yield Curve Control (YCC), about which I am preparing a specific report these days to explain what it is.
This is a crucial topic going forward and that is why is the cover of this report. We are very likely to enter a new (but very old) era of yield curve control, similarly like a ship passing the ancient Hercules’ columns and going into the unknown. This passage has been done before, but what is unknown are the consequences.
I also attach a portion of a recent report by Berry Bannister of Stifel which, taking all the information above (decreasing earnings, rising inflation but keeping rates at relatively low levels), leads to a rather natural conclusion: that we are heading towards a period of Staglfaction.
Bannister points out how the current situation is very similar to 1999 and that valuations don’t matter, until all of a sudden… they do matter (like in 1929, 1999, and 2021).
The above is not intended to conclude that I think stocks are at the beginning of a new financial crisis, absolutely not. But I believe it’s right to primarily provide you with some evidence (I haven’t continued due to length, but I can assure you that we monitor an infinite number of data and indicators, and that they all point in the same direction, the one just presented to you) to explain in some detail the current situation and therefore the reason why portfolios are conservative. The above description doesn’t indicate when a retracement may occur, but we believe that given the current values of both the American and European stock markets, the risks associated with American refinancing, and the countless exogenous variables currently present, we believe there is little room for further advances in stock markets, and therefore we could expect some sideways movements at best. Or we could consider the August-October period, statistically the most volatile period of the year, which usually offers the best entry point for stocks in October, ideally to be maintained until the following May.
It turned out to be a dense report both in terms of the amount of writing and the number of charts, but I believe it is useful to provide an idea that is more in line with reality.
