November 10 2022

Market Prices 20% off: Is This Bargain Season?

As the ominous Black Friday approaches with loads of juicy bargains, it is good to remember that a purchase, even with a 20% discount, is still a negative cash flow. Similarly, not all investments are good deals.

Investors found the 20% discount on the S&P500 really attractive on Thursday. They interpreted the slightly lower print on CPI on Thursday, 0.2% lower than expectations, as the end of the higher rate policy, and therefore a time to buy assets again. Cyclical assets, such as Real estate, Consumer discretionary, and Tech were all up north of 7%. At the rate curve was repriced, demand increased for bonds and risk assets alike.

When making such an investment choice, investors bet that they can make more than the 3.5% annualized they get on their cash. Is that a sound expectation?

Bonds pay a yield, but appreciation is capped at 100 (or par). US 2-year treasuries are now yielding 4.3%, a 0.8% premium to cash. It is probably a fair deal. It is less clear on longer-dated US treasuries (as curve is inverted with 10-year at 3.8%) or corporate bonds.

Equities pay dividend, with unlimited upside and the risk to go down to zero. S&P500 equities yield 1.7%, and you’ve got to believe that the capital upside is at least 1.8% to switch out of cash. Goldman Sachs prediction for SPX at year-end is 3600 for 2022, and 4000 for 2023. Assuming current level is 3900, there is a 2.6% upside potential in the next 12 months. Granted it is higher than 1.8%, but not a great risk premium.

We need a second opinion, call the fundamentals please. Corporate earnings are revised down. Inventories increase. Marketing budget are slashed. Layoffs are rolling out. While it hasn’t impacted morale yet, it is expected that cash flows will come down for households and companies alike. All things being equal on share price, price-earnings (PE) ratio will look more expensive. S&P’s PE ratio has come a long way down, and is now in line with the past 10-year average. Can it afford to start going up now?

Don’t be fooled, the Fed is not done yet. Market exuberance is precisely what would embolden them to tighten further. They don’t want financial conditions to improve for now. Too soon for an end to misery. But a shopping spree lifts up the spirit every now and then, right?


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360 Advisory LLC is a Boston-based RIA managing investments, including crypto