Welcome back for a timely June edition of The Markets in Three Charts.
Back in the December 2021 edition of The Markets in Three Charts we looked at three macro charts that displayed how stretched US valuations had become and how vulnerable the total market was to the possibility of rate hikes. In this edition we explore several economic and financial charts to help examine what's changed since our last dive into the macro environment, and consider timing the market vs dollar cost averaging in falling markets.
If you've been in a supermarket or at a petrol pump in the US, UK, or Australia, your (electronic) wallet will be left lighter upon leaving than the same visit a year ago. Inflation has been a reigning concern not only for investors and companies, but also for central banks that maintain an employment and inflation target.
CHART 1 – Central bank policy rates around the world
With inflation in the US and UK around 9% and Australia following the upward trend above target, central banks have struggled to maintain expectations that inflation can be controlled. This has lead to escalating rises in the official policy rate as shown in the chart above.
The aim of these rate rises is debatable depending on the economic school of thought that one subscribes to, but the effect of dampening business investment through making borrowing more expensive is observable throughout prior hiking cycles.
This flows through to employment and therefore inflation (or so the central banks hope). The concern is that this inflation cycle has been fired up by supply side constraints and booming demand, as well as the lingering effects of massive covid-era government stimulus, making monetary policy the least effective tool in the box to solve our current predicament.
In turn fixed income yield curves have rapidly shot upward with some of the largest daily moves in 2 & 10 year yields in the last ten years. Additionally, with the inversion of the US 10 & 2 year Treasury Yield and pull back in equity markets, investors have signalled bearishness and pessimism concerning the overall economy.
CHART 2 – Latest Shiller cyclically adjusted price-to-earnings ratio (CAPE) 30-year average
As we observed in the December edition of this blog, valuations (based on the CAPE) were above average, implying below average expected long-term returns. Since the beginning of the of the year, when the CAPE was sitting near all time highs (38), the S&P 500 has retraced around 20% of its value.
It now sits around 28, in line with its thirty year average but still 1 standard deviation above its full series data. If like us you view markets in terms of distinct regimes of 10-30 years with overlayed monetary, fiscal and debt cycles, valuations may soon seem cheap for the period as continued downward pressure sends certain equities into irrational/liquidity rush territory.
CHART 3 – Dot Com Bubble, 2008 GFC, Covid-19 peak to trough
The question on many investors mind is how long does this bear market have to run. Many have looked to the past as a rough guide to the future. The last bear market happened when the COVID-19 pandemic started lasting 33 days, and the market went down 33.9%.
Other bear markets in the past 30 years lasted far longer with the GFC needing over 350 days to go from peak to trough. If this bear market is more like the 2000's dotcom bubble with similarity of a reset in tech valuations then perhaps we have longer to go.
H&G High Conviction Fund has maintained a healthy cash and gold level since last year and our portfolio of low-leveraged companies has weathered the storm in the micro cap space. We believe the next six months will provide ample, once every decade opportunities for value investors like us
Thank you for reading & good luck out there.
If you'd like to know more about H&G High Conviction Fund, please contact Joseph Constable: +61 431 886 186.
You can sign up to our newsletter and follow us on Twitter or LinkedIn for regular updates and musings.
Equity Trustees Limited (“Equity Trustees”) (ABN 46 004 031 298), AFSL 240975, is the Trustee for H&G High Conviction Fund. Equity Trustees is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT).
This newsletter has been prepared by H&G Investment Management Ltd (ACN: 125 580 305; AFSL: 317155) to provide you with general information only. In preparing this report, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither H&G Investment Management Ltd, Equity Trustees nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Information Memorandum before making a decision about whether to invest in this product.