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November 2022 Newsletter: All about the earnings

Equity markets have been strong this month and while we were slightly up in November, we exited the field (fully hedged1 the portfolio) too early. This is never easy, but we do think that equity market investors have been far too sanguine during much of November, and especially in the second half of the month. 

The equity market seems to think that by signalling that a slowdown in the pace of rate increases, the US Federal Reserve has opened the door to a super bullish environment. We are not sure about this at all. From our perspective the slowdown in the pace of rate increases is sensible, but, as the governor of the US central bank said, this means that the final peak in interest rates is probably higher now than the market expects. By lengthening and moderating the campaign of tightening the US central bank appears to want to prevent a sudden crash in the economy and consequently to prevent them having to ease policy again before inflation is fully defeated. Investors, in our view, have become rather overexcited by the slowdown in the rate of tightening. The reality seems that the current tricky environment is likely to be more drawn out and trickier than many expect. 

We do not believe that the current bear market is over and that bullish investors could be in for a shock, for several reasons. The first is that quantitative tightening is still ongoing – especially in the UK. The second is that yield curves (especially in the US but also in the UK) are quite negatively sloped. In the US the yield curve was last as negative as it is now in the early 1980s. The implication here is that a notable recession appears to be likely, at least as indicated by the yield curve. The yield curve is already more negatively sloped than it was prior to the year 2000 downturn and even than the early 1990s recession. Both downturns were strong and real recessions, especially the one seen in the early 1990s. Finally, we follow a fast-moving survey of economic activity in the US which is already indicating a strong downturn in economic activity. This data comes out weekly and as a result is much more timely than official monthly information. Unless this data series turns up soon it implies that a strong recession is on the way – and this will have a real and potentially quite negative effect on corporate earnings. We can foresee a moment next year when earnings estimates are falling sharply and that interest rates are not being cut in response (as they normally are in this sort of situation). This would not be a bullish environment. Finally, although valuations have come down, they are, at least from a cyclically adjusted perspective, not at all low. At just under 30x cyclically adjusted earnings US equities (this is where we have a long data series) are still trading well above a median level of around 20x, and more importantly, the current level of valuation implies a negative return for US equities over the next ten years. This is not a sign for a bear market low.

The memory of financial markets can be short. Few working today were probably working in markets during the early 1990s recession. By contrast the downturn most recently in the mind of market participants is what happened during the COVID outbreak. This was very different to a normal economic downturn. During COVID, interest rates were cut to virtually zero while a huge amount of money creation was set loose. At the same time, due to programs such as the furlough scheme, unemployment did not really increase. The consequence of this is that investors may believe that a situation where interest rates get cut to zero, but where no one loses their job, is normal, and this is what may occur in the near future. This seems, given current conditions, very unlikely. In the year 2000 – 2002 downturn stock markets were falling while interest rates were being cut. The same was true in 2008-2009. This is because corporate earnings were falling faster than interest rates were declining. For equity markets to make sense here investors seem to want to have their cake and eat it. That interest rates will peak and then fall while company earnings do just fine. In COVID they did have their cake and eat it – this time perhaps not. 

Consequently, we will proceed with caution and as normal, would like to thank all our supporters.


AstraZeneca 7.6%
Rio Tinto4.0%
Compass Group2.6%
National Grid2.6%
Reckitt Benckiser1.8%