Market Commentary 17th of May 2022

Rates Easing

Global rise in benchmark interest rates are expected to slow as reflected on the 10-year US Treasury Yield. It tested its previous high back in 2018, breaching the psychological barrier of 300 bps lately. This is an important level and the rates has stayed below this level since 2011 post Global Financial Crisis.

In the last couple of days, we are seeing this 10-year yield falling below the 300 bps mark and I believe that some form of mean reversion will take place to further consolidate, considering that it has climbed a whopping 150bps (close to a 100%) from its January 2022 lows; a period of digestion is more likely.

This should give the market more breathing room as market digest the 1st quarter results and economic data that were recently released. Labour market remans strong which is the only brightspot in the US economy. As labour participation rate in the US continues to rise, labour cost should have already peaked or peaking. This is a key concern by executives as mentioned in many companies recent earning calls. But it will still take some time for the cost-push inflation to eventually ease.

Energy prices have stayed elevated in view of the Russian War. Big caps energy stocks have been testing their resistance of late. Shanghai is expected to end covid lockdowns on the 1st of June and more businesses will be allowed to operate. This may be another potential source of tailwind for the energy sector.

If everything goes as planned, Chinese government may start to implement fiscal policies more aggressively in the second half of 2022 to meet its GDP growth target of 5.5% for 2022. Supply-chain constraints may finally see some form of easing as well.

S&P500 Forward PE falling below 10-year average

The S&P500 Forward PE fell below its 10-year average for the first time on the 12th of May. Forward 12-month EPS estimates for the index was $237.18. Thus, based on the closing price on 12th of May, the forward 12-month P/E ratio for the S&P 500 16.6x. The forward 12-month P/E ratio of 16.6 on May 12 was below the five-year average of 18.6 and below the 10-year average of 16.9. However, it was still above the next three most recent historical averages: 15-year (15.5), 20-year (15.5), and 25-year (16.5).

At the sector level, five sectors had forward 12-month P/E ratios on May 12 that were below their 10-year averages, led by the Energy (9.9 vs. 15.8) and Materials (13.6 vs. 16.2) sectors. On the other hand, five sectors had forward 12-month P/E ratios that were above their 10-year averages on that date, led by the Utilities (19.9 vs. 17.1) and Consumer Staples (21.2 vs. 18.9) sectors. One sector (Health Care) had a forward 12-month P/E ratio equal to its 10-year average (15.6).

Key points to note:

1. Analysts are still projecting a record high EPS for the S&P 500 of $229.22 for the year 2022 and $251.22 for the year 2023 on the 12th of May 2022.
2. Global economies are still in the process of reopening post-covid, especially China which is a major exporter of global goods.
3. Russian and Ukraine War has been ongoing for a number of months now, and if this war stops, the global inflationary pressure should ease as well.
4. Record high saving rates during the crisis should provide another source of buffer for the US economy.
5. There is the talk of a global recession lately, but my take is that the possibility of it happening is not high.
6. It has been since 1981 when equities and bond prices were moving in tandem. That was also the days of high inflation in the US economy and eventually, rates were raised to a level that caused a recession but eventually took out inflation. Investors are also concerned with our current inflation situation as they believe that the FED will similarly, raised rates aggressively to curb inflation but could not avoid a soft-landing.
7. My opinions are that the equities is heavily mispriced, especially the growth sector as market is pricing in a worst case scenario. NASDAQ has entered a bear territory since as a result. As rates starts to reverse towards mean, we should see some form of support for this sector.
8. As we have seen major pullbacks in the US market, margin calls and deleveraging had worsen the stock market meltdown. Remember that margin calls are irrational, investors sell to cover margin levels and not related to either macro or micro factors. Thus, I see that in times like this, investors will be able to pick up good technology companies which are generating good cashflow at a discount.

Happy investing!!!