(More) patience required
As is often the case, the most important developments across financial markets this month are what is not shown through share price movements. On Monday morning, ANZ (ASX: ANZ)'s economics team mailed out its latest economic forecasts for the US economy. The changes are quite noticeable:
"Based on current and expected price trends we now forecast a terminal Fed funds range of 4.75-5.00% to be reached by Q2 2023, which is 100bps higher and almost six months later than we previously projected."
In layman's language - the Federal Reserve will be tightening for longer and pushing up interest rates a lot higher than previously assumed. I believe this has not been priced in yet by financial assets.
Equally of importance - the economists at ANZ Bank are now reviewing their forecasts for the RBA to have its own potential "higher-and-longer" scenario.
It goes without saying - ANZ is but one forecaster in a global world of many. But Monday's update is indicative of the trend that started early in 2022 - and the same undercurrent has remained in place since. Inflation is much stickier than assumed, and central bankers will need to work harder to pull it back towards 2% again.
Just about every economic outlook has the US, and the world in general, either close to or in recession next year. Imagine what higher interest rates for longer will do for the risks of a recession.
It all comes down to earnings
Financial markets are transitioning away from the pre-2020 era. From exceptionally low interest rates and bond yields with low inflation to much higher rates, bond yields, and much higher levels of inflation.
It's not just central bankers and economists who have been underestimating how far and how long this process of taming inflation is likely to stretch out. The same observation can be made about investors and financial markets generally.
Nine months in and it is possible we're only halfway through what needs to happen. In addition, the bulk of the consequences (slower growth, higher unemployment, less liquidity) are still ahead of us.
Having said this, it does not automatically mean the only way forward is a steady regression into a full blown disaster. There are still plenty of what-if scenarios that can push equity markets in either direction between tomorrow and 2024.
Citi strategists summed it up as follows recently:
-Positive scenario: inflation comes down quickly, allowing central banks to stop tightening sooner - equity markets rally circa 20%
-Negative scenario: inflation remains sticky and central bankers need to continue tightening, causing a global recession - equity markets sink by -20%
Citi's base case scenario for the US economy is to see two quarters of negative economic growth in the back half of 2023. But its strategists also believe corporate margins and profits will prove more resilient. Thus, equities should be able to continue clawing back more of the losses suffered earlier this year. This is why (in the short term) the nascent US quarterly reporting season might be more important than this week's FOMC meeting.
Did FedEx (NYSE: FDX) teach us anything?
On Friday, freight giant FedEx issued a severe profit warning, with management at the global transport and e-commerce services firm withdrawing guidance for the full year. The company has been seen by investors to be a bellwether for the US economy's performance.
The shares were punished by -21% on the day - the worst one-day fall in the company's history - and subsequently pulled down all peers around the globe.
FedEx management spoke of a sudden and severe deterioration in business momentum. But thus far, investors seem to be treating FedEx's problems as purely related to its e-Commerce businesses. But what if it isn't? Upcoming quarterly updates from corporate America might provide us with more insights.
Why now is the time for more patience
If we had the choice, most of us would just want to get a recession over and done with so we can finally move on and look towards a brighter outlook. Alas, there is no such choice and this global transition remains an elongated, drawn-out process.
Only halfway? It is but a genuine assessment. This is not the time to lose patience.
How exactly an investor should treat or respond to the ongoing uncertainties is very much a personal journey, defined by key characteristics such as your appetite for risk, your specific strategy, and your years of experience.
Some people can go on a holiday with nothing but a swag bag on a motorbike while others will never get used to even the more glamorous form of 'glamping'. Investing is not that dissimilar.
What the professionals are doing
Last week, I accidentally bumped into Nick Griffin of Munro Partners being interviewed on the ABC. While the journalist was trying her best to extract some regret on a day US equities had sold off heavily, Griffin stoically implied he never judges his investment decisions for one particular day only.
Munro's international fund went 40% into cash earlier this year. This has since been reduced to 30%. Those are big numbers for a fund that directs some $4.7 billion in client money.
Griffin suggested it's a process before also adding financial markets are forward-looking. So while central bankers and economies might need more time to adjust, it is likely the time to start buying more shares might "only" be three to six months out.
Marcus Padley of Marcus Today, on the other hand, moved to 100% cash once again.
For those who do not read the local gossip press, Charlie Aitken is no longer a fund manager and has returned to his former role as a private client advisor at Bell Potter. Aitken's forecast is for more (and extreme) volatility in the months ahead.
Get rid of the stinkers in your portfolio, is Aitken's advice, and draw up a list of all the great, quality companies you like to own. Keep enough cash at hand for when such stocks get clobbered. The benefits should last for many years. Aitken also advises if investors cannot stand extreme volatility in share prices, they might want to consider moving to the sidelines for a while.
For our part, the FNArena/Vested Equities All-Weather Model Portfolio has equally kept its cash allocation at super-sized levels in 2022. Cash levels are still currently above 30%.
Read the surveys
More insight can be derived from two large global fund manager surveys. The monthly survey conducted by Bank of America revealed bearish sentiment is currently rife with average cash allocation at 6.1% - the highest level post 9/11. The survey by S&P revealed expectations of negative returns from US equities near-term are now pretty much embedded in investment managers' minds. Nearly 80% see a recession on the horizon, but only one in ten is predicting it will be a deep one.
The good news from the S&P survey is that bearish sentiment has climbed from the worst levels seen earlier this year.
The BofA survey showed global investors are extremely cautious on European equities ("most underweight ever") and have positioned themselves en masse in consumer staples ("most overweight since December 2008").
Global growth expectations are now at or near their lowest levels ever recorded with excessive and persistent inflation being seen as the number one risk. Well over 90% of investors see corporate profits declining over the next 12 months.
The BofA statistics suggest global investors have never been this underweight in equities - they are now even more bearish than they were in 2008. Healthcare, Staples, and Energy are everybody's favourite exposures with the S&P survey also identifying technology as a favourite sector. And just like here in Australia, consumer discretionary and real estate stocks have little to no friends, but overall sentiment has also noticeably deteriorated towards basic materials.
The above easily explains why daily trading volumes for the ASX200 were down 19.6% in July relative to the 12-month average, and 13.7% throughout August.
But the irony is such extreme downbeat readings increase the chances of a counter-sentiment move. In the current context, this would be another rally nobody believes is sustainable.
This is a point highlighted also by the aforementioned strategists at Citi whose proprietary indicator is suggesting overall risk appetite is close to sinking into "panic" territory yet again, which usually implies the next rally upwards is but an unexpected trigger away.
It will not, however, mark the end of this year's ongoing process which has a lot longer to run. Don't run out of patience in the meantime.
But also keep in mind: 20% downside is still just as likely as 20% upside.
My final observation
If Quantitative Easing (QE) by the Federal Reserve contributed to the relative outperformance of US equities over Australian equities pre-2022, then it is most likely the reverse of Quantitative Tightening (QT) will contribute to Australian equities performing relatively better. We've already seen that year-to-date.
FNArena offers truly independent and impartial market commentary and analysis, alongside proprietary tools, data and applications for self-researching and self-managing investors. The service can be trialed at (VIEW LINK)
Never miss an insight
If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.
And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.
MORE ON Equities
There are 20 stocks with yields higher than 10% on the ASX... Here's why this fundie hasn't invested in a single one
2 stocks mentioned
2 contributors mentioned