Market bounce but no bottom in sight

Chad Padowitz

Talaria Asset Management

Since mid-June there has been a powerful rally in global stock markets. The idea that the US Federal Reserve might have turned dovish combined with a US earnings season that contained few negative surprises has juiced share prices.

The question on investors’ minds is: is this a sign of the market turning, or just a countertrend move in a bear market? For holders of Australian shares, the current reporting season adds spice.

Whilst the noise is distracting, even enticing, there are three strategic factors that we want to focus on in answering the question. And we also want to concentrate on the US because it remains by far the most important influence on global financial markets.

1/ Fighting uncertainty on inflation and corporate profitability

With the tone set by politicians and central bankers, war in Ukraine and supply chain disruption have dominated the debate over the direction of inflation. Whilst these have been central to an understanding of ballooning headline prices, the driver to core inflation is services. And it is consumption that drives services, not war, not supply chains.

For the first time in a generation the labour market is tight. Participation rates and unemployment are low, there are many more job openings than workers available, and the risk of a wage spiral is live. 

In this context, it is audacious to assume the Fed has or will imminently move to a stance more supportive of financial markets.

Inflation is not the only area of uncertainty. Whilst we are confident that the outlook for earnings is poor, it is challenging to say exactly how bad things might become and for how long. Nevertheless, certain recognised relationships between economic measures provide clues.

For example, the ISM manufacturing index, a leading economic indicator, tends to lag inverted 10-year bond yields by about 18 months. The ISM in turn, runs ahead of moves in corporate earnings by about three months.

If these relationships hold, US profitability may not trough until the second half of 2023 and at a level considerably below current forecasts – the ISM’s relationship with inverted bond yields is not just in terms of direction but also magnitude.

2/ High valuations

Given the uncertainty concerning inflation and corporate profitability, you might expect valuations to be low. After all, if it is hard to forecast future cashflows and difficult to work out what one should pay for them, the least valuation might do is provide a considerable buffer against loss.

However, US shares are costly. Recently the Shiller Price Earnings Ratio, a much-watched valuation measure that adjusts for earnings and smooths out cycles, was 31.5x for the S&P 500. In the more than 140 years for which data are available it has only been higher than this for a total of 5% of the time.

3/ Geopolitics dominating economics

If thinking about financial markets was not intricate enough already, the instability in geopolitics is adding complexity.

The tragic war in Ukraine has had knock-on effects felt around the world, most obviously in terms of energy and food prices. And the recent visit to Taiwan by Speaker of The House of Representatives Nancy Pelosi has been, if nothing else, a reminder of the currently fragile relationship between the US and China.

Perhaps this has always been the case, but when it comes to weighing political against economic interests, politics is trumping economics.

We believe that we are seeing a rally in a bear market rather than something more sustainable. But we have also been around long enough to know that anything can happen, in which case we would encourage investors to build a portfolio that is robust in a range of outcomes – the founding principle of diversification.  

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The information in this article is general information only and is not based on the objectives, financial situation or needs of any particular investor. In deciding whether to acquire, hold or dispose of the product you should obtain a copy of the current Product Disclosure Statement (PDS) for the Fund and consider whether the product is appropriate for you. Units in the Talaria Global Equity Fund (Managed Fund) (the Fund) are issued by Australian Unity Funds Management Limited ABN 60 071 497 115, AFS Licence No. 234454.Talaria Asset Management Pty Ltd ABN 67 130 534 342, AFS Licence No, 333732 is the investment manager and distributor of the Fund. References to “we” means Talaria Asset Management Pty Ltd, the investment manager. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. In deciding whether to acquire, hold or dispose of the product you should obtain a copy of the current Product Disclosure Statement (PDS) for the Fund and consider whether the product is appropriate for you. A copy of the PDS is available at australianunity.com.au/wealthor by calling Australian Unity Wealth Investor Services team on 13 29 39. Investment decisions should not be made upon the basis of the Fund’s past performance or distribution rate, or any ratings given by a rating agency, since each of these can vary. In addition, ratings need to be understood in the context of the full report issued by the rating agency itself. The information provided in the document is current at the time of publication

Chad Padowitz
Co-Chief Investment Officer
Talaria Asset Management

Chad is the Co-Chief Investment Officer and co-founder of Talaria Asset Management. He has more than 20 years’ experience in the financial services industry in the UK, South Africa and Australia. Talaria's investment strategy seeks to increase the...

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