When Does This Break?

2021年8月23日

Eagle eyed viewers of this chart might be able to see that something is *different* between 2010-2019 and 2020-2021. The slope of the market's ascent over the last 16 months has been nothing short of astonishing, and it's more than double the slope of the previous decade. Even if you make the chart a log chart, the slope of the recent recovery is still higher than the previous decade's average price action. This warrants asking "when does this break".

To be able to make a guess at that, one must first understand why the market has done what it's done. Here at Discordia, we think there are a few key reasons for the breakneck ascent.

1.) Fed - We know, we know. You're sick of hearing about the Fed. We are too. Blaming the rally on the Fed has almost gotten so cliché to the point of tedium, but there is some truth to the fact. However, they helped in a way which is somewhat counterintuitive, and different to popular understanding. When talking about the Fed, most discuss the asset buying programs and the Repo market intervention, and while those things helped overall market stability, what they actually did was increase equity risk premium. Not by increasing the risk of holding stock, but by decreasing the risk of holding bonds. If situations in the future crop up where the solvency of U.S. companies comes into question, there's no doubt about what the Fed will do - having recently purchased bonds up and down the quality matrix. They even set up a SPE for the buying of JNK. This massively reduces the risk of bondholding in general - if uncle sam will bail you out of your investment - and thus bond yields have generally plummeted, having a chilling deflationary effect. With lower yields, equities look comparatively more attractive, and so that's where the flows have gone.

2.) Growth - The fed backstopping the market allowed investors to go into the equity markets, but it also essentially allowed analysts to write off the entirety of 2020. Some companies went out of business, sure, but most public companies (> 1B market cap) survived, and the people responsible for assigning fair value to them basically just pretended 2020 didn't happen. This is evident if you go back and look at lot of the institutional analyst coverage over the last year. Analysts stopped caring about the short term hits to businesses, and put their collective focus squarely on the "catch up" growth in GDP that public companies were sure to take part in. This allowed multiples to remain buoyant as the 'real world' was crumbling, and has this sentiment has sustained the rally long after most pundits predicted.

3.) Sentiment - Given all of this, figuring out when earnings growth will peak is the main question for the medium term in the markets. We track 7 of the most important leading fundamental sentiment indicators here at Discordia, and only one of them has a bearish reading - the UMCSI - which we made a post about a week or two ago when it came out particularly negative. The rest are relatively bullish. For now.

Our overarching thesis is that earnings growth will peak when overall business cycle sentiment peaks, and that can be forecasted by these crucial, leading indicators that we track. Once they turn, its anyone's guess as to what happens next. When this happens, though, we suspect the chart won't look as rosy as it has for the last year and and a half.

Cheers!