Consensus Earnings Estimates Are Historically Wide
Has the 2022 bear market ended? It is unclear even for most market forecasters. The spread of 2023 consensus earnings estimates is historically wide.
Whether the 2022 bear market is ending may seem a fruitless question. Most market forecasters got 2022 wrong. Even today, 2023 consensus earnings estimates vary widely from high single digits to negative 15%. Added to that are the market historians who point to various pervious market downturns over the last century to support their views. Which collectively suggest that the likelihood of 2023 being a down year is low. But what is the reality. Will stocks bounce back in 2023?
The answer is not so simple. It hangs on a multitude of conditional expectations which make prediction difficult and path depemdent. In particular, the path for inflation and rates. Both of which will impact growth and realisable corporate profitability.
Adding to the complexity are the causes and solutions to the current inflation mix, with both commodity inflation and wage inflation being the most tenacious to tame. If monetary policy fails to bring inflation down without a disproportionate decrease in growth, even the current depressed multiples may prevent a stock bounce back in 2023.
In the meantime, the smart money seems to have a preference to ride out 1Q23 with a portfolio tilted towards the quality, dividends and credit.
Benjamin Graham, if he were alive today, or even an investor from 2019, might struggle to comprehend the bull market we witnessed in SPACs, crypto, stonks and NFTs. A year ago, investors were buying monkey jpegs for millions of dollars or profitless tech companies promising jam tomorrow. This extraordinary period was a bull market in the willingness to believe. But exposing the truth has drawn a tear.
Three Reasons To Hedge
Is too late to hedge portfolio risk. Investors painfully acknowledge that multi-asset portfolios were challenged in 2022 from three sides.
One big question today is whether it is too late to hedge portfolio risk. Investors are dealing with three challenges that are impacting their portfolios:
1. Extreme equity volatility.
2. The popular 60/40 portfolio did not diversify risk as expected.
3. Steeply rising rates and an inverted yield curve.
Perhaps the damage is done and the best strategy now is to simply stay invested. Or should investors consider alternatives? Reading around the investment research inside RFPnetworks there is an emerging consensus that the recession will be shallow but protracted. With a potential turning point centred around mid 2023. But what if this is not true. What if the terminal rate required to bring inflation back under control is higher than what the FED now expects. The FED has already revised this upwards since September 2022. Even more concerning for investors is the risk that rate cuts don't come in 2023 at all!
The efficacy of unconstrained, benchmark agnostic or at the extreme, an anti-beta hiding strategy may be needed now. At least, this topic seems to be getting a lot of traction in our research feeds.
Not surprisingly, anti-beta equity strategies did very well for investors who followed them in 2022 – after all, performing well when the stock market as a whole is doing poorly is exactly what such strategies are supposed to do, and 2022 was a very bad year for equities. Now, investors are hoping 2023 will bring respite from central banks’ punishing interest rate hikes and a resurgent stock market, and many might be thinking equity hedging will no longer be a winning strategy. They might be wrong.
In A Bear Market, Global Outlooks Get More Clicks
It's that time of the year that global financial market outlooks fill our research feeds. Interestingly, in a bear market outlooks get read more.
It's that time of the year that global financial market outlooks fill our research feeds. They are popular throughout the entire business cycle. But this time around clicks have gone through the roof.
We only can conclude that investors are feeling pain in their portfolios. And are looking for the right medicine to soothe their dry throats. As the bear market firmly takes hold, 60-40 portfolio stop working, and the economy heads towards recession, investors are clearly looking for new ideas.
Here are the Top 10 Investment Trends that are getting the most attention from investors. We update these when we see a lot of traction for a specific topic by investors inside RFPnetworks. The idea is to ensure other investors don't miss these trends. And to help investment content writers at Investment Management companies produce timely insights on the markets where investors are focused.
Investors Recalibrating. Change Ahead.
When Capital Market Assumptions change, investors are forced to re-evaluate their strategic asset allocation. Portfolios could change.
Given the amount of clicks for long term risk premia estimates across all asset classes, we can only assume that Chief Investment Officers and Strategists are refreshing their portfolio assumptions. There's a lot happening on the macroeconomic front as inflation and rates rise, and global growth is continuously revised downwards. This type of research trend on RFPnetworks has historically preceded significant portfolio rebalancing by our clients.
60-40 portfolios may struggle.
Municipal Bonds have experienced significant outflows, bringing valuations down to relatively attractive levels compared to Corporate Bonds.
With Municipal Bonds trading at attractive valuations, higher yields versus treasuries, together with strong credit fundamentals, renewed dialogue between Professional Investors and Municipal Bond investment managers is taking place.
The attractive valuations of Municipal bond can be attributed to nearly $60 billion in outflows year-to-date through May 25. And is most noticeable amongst the most liquid segments of the market, including both the 10 year AAA bonds and the well known High Yield names.
Looking back historically, Municipal Bonds often exhibit large net outflows during uncertainty. Today's situation runs parallel to the extreme outflow periods during the Global Financial Crisis, Municipal Bond Scare, the last US Election, and now the COVID period. What exacerbates the situation today is the reality of rising rates.
But what is supporting the investment case for Municipal Bonds today?
1. Tax Revenue Collection - A year-on-year increase of 22% (2021 versus 2022) has resulted in a 19% increase on pre-pandemic levels.
2. Protection against Lower Growth - With consensus growth estimates now being revised downwards, investors are looking at historical default rates and down-grade trajectories during past recessions. The historical metrics suggest a relatively better picture for municipal bonds versus corporates.
3. Thematic - The attractiveness of exposure to either short duration high yield or stable income generated by essential infrastructure projects, bodes well for today's portfolio priorities.
And whilst recession may bring financial headwinds to certain sectors, such as higher education, the 7.6% decrease in the first five months of 2022, take Municipal bonds to their cheapest levels since late 2020. The relative value of Municipals versus Corporate Bonds in a rising rate environment is now high on the research agenda of many professional investors
Assumption Have Changed
Stock-Bond correlation in 2022 has broken the classic 60-40 assumption base. What happened and how should portfolios adjust?
What has led to the breakdown in stock-bond correlations in 2022? Inflation? A changed macroeconomic environment? Will the 60-40 portfolio ever work again? Or should it be recalibrated back to reflect the covariances of a different decade.
Questions such as these are at the forefront of portfolio design today. The classic long equity volatility and bond duration portfolio is not working, and is causing a conundrum for asset allocators.
Read the latest views from strategists and view their capital market assumptions inside RFPnetworks.
Let's Look At Causality
Definitions of stagflation vary. What is more interesting is causality and effect. But even the models fail to find consensus, which raises key questions.
Depending on which economist, strategist, equity or fixed income portfolio manager you follow, the view that we are now in stagflation varies. But that difference in opinion is not the interesting thing. What is more interesting is the variation in the underlying models and analysis they point to, in order to draw their conclusions. The lack of consensus is notable.
There is the orthodox view that inflation is a result of supply and demand imbalances: With monetary and fiscal leniency granted to support economies through COVID, driving demand; And supply chain blockages suppressing the just-in-time delivery of goods, the inflationary logic follows. From a demand perspective, hiking rates to stem demand is the classic monetarist doctrine. And that is what is happening in the US, UK and soon in Europe (but interestingly, not in Japan!!!).
The result: asset prices and disposable income decline as rates rise, creating a negative wealth effect. And a higher cost of capital that reduces investment. i.e. monetary induced demand control to remove inflationary pressures.
But what if the driver of inflation is more skewed towards supply and not demand. i.e. variables which are beyond the control of monetary policy. Specifically, a persistent zero-COVID policy in China disrupting manufacturing and shipping. And the duration of the Russia-Ukraine crisis prolonging heightened food prices and energy costs that impact households and the final price of manufactured goods.
The result: Hawkish monetary policy will have limited impact on supply driven inflation, and primarily impact growth negatively.
Whilst consensus GDP forecasts point to low single digit growth for Full Year 2022/3, inflation today is still at high single digits. And Jackson Hole is just around the corner. These statistics and fears may explain the high volumes of investor traffic in our PRO site researching "which assets do well in stagflation".
ON INVESTORS MINDS
Capital Market Assumptions are a core input into investment plans. But they do change and right now, those changes are impacting investors globally.
Are future asset class assumptions for expected risks, returns and premia affected the current macroeconomic policy direction? Or are should ALM studies be recalibrated?
Compare capital market assumptions from across the investment manager community inside RFPnetworks.
Impact Of The End Of Free Money
In the current market, the supply of alpha is abundant across asset classes, countries and sectors. In contrast, the end of free money may impact beta.
The period 2009 to 2021 produced the strongest bull market in history. During this period, easy money, historically low real short and long term rates, and exploding central bank balance sheets drove market beta across fixed income and equity markets. Spreads continually tightened across all fixed income segments, corporate profits multiplied, and generally accepted P/E's got ratcheted higher by un-phased investors. But things have changed.
Traditional portfolio design since 2009 relied upon several givens: Predictable asset class diversification, globalisation driven cost reductions, and benign real credit risk premiums. All of which have now changed. Perhaps permanently, or at least for the foreseeable cycle.
A reliance on beta and unlimited liquidity may not work for much longer. Inflation has taken hold, rates are rising, and Capital Market Assumptions are changing.
Professional investors are being forced to reconsider their investment portfolio design. The efficacy of passive investing going forward is being questioned. And active asset managers are raising their voices, pointing to the abundant supply of alpha across asset classes where region, country, sector and company return dispersion has widened. Curiously, the professional investor community is listening.
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