Lower Rates Trumping Lower Earnings for Stocks
Bonds and equities have rallied hard lately on the back of optimism that both economic growth and inflation are now on a “glidepath lower”. Markets and economic data are often described as collective “Rorschach Test”: observers see what they want to see. Currently, Bulls and Bears are looking at the same undeniable trends but coming to opposite conclusions.
The optimist looks at the data deceleration in October and November as a positive because it means that the Fed is not only done hiking but will soon be cutting rates. The pessimist looks at the same data and might say: good for bonds but why am I buying equities when a slower economy will beget weaker corporate earnings and increases the risk of a recession?
Ultimately, equity performance relies on the “glidepath” to keep on slowing but only slowly and not too much. If demand decelerates too fast, recession drums will get louder, and the current 12% EPS growth priced in and assumed for 2024 will have to be revised considerably lower, thereby either pushing multiples higher or stock prices lower. The optimist would argue that lower yields would justify multiple expansion and therefore, even if earnings fall, don’t worry, lower discount rates mean multiples, especially of long term cash flows (tech) can and will expand.
Our humble view is that what happens next, in the near term, is unknowable. That is why we focus on where we do have conviction and that is on our longer-term themes: Labor markets are secularly tight. Potential GDP growth (the rate at which the economy can grow without inciting inflation) is lower going forward than what we have enjoyed in recent decades and the emergence of global protectionism is inflationary. So, while we refrain from making short-term market calls, we will reiterate what we have been saying, which is that your risk reward in equites isn’t very good. Multiples are high, and the never previously achieved “soft-landing Nirvana” is priced in. The Great Moderation of lower rates and lower inflation volatility is over, which suggest that, over time, equity multiples will compress. Have a great weekend and try to tune out the short-term noise.
Tim Pierotti is WealthVest’s Chief Investment Officer.
Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.
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