Morning Note: The Disconnect

Sticking with our recent rock-and-a-hard-place theme, here's Bloomberg macro analyst Cameron Crise yesterday on the earnings risk stocks presently face:

"...it is likely to be earnings, rather than the trajectory of interest rates, that hold the key to the next big moves in the stock market.

Thus far, the deterioration in expectations has been relatively modest... but it’s nevertheless been notable relative to the trends of the last couple of years.

It’s one thing to navigate a hawkish Fed when nominal earnings expectations are still rising, but quite another when your profit forecasts start to fall.

Buckle up, because things could be about to get pretty spicy again."

That said, and, by the way, we agree, keep in mind that we remain fairly sanguine in terms of the severity of the coming (we think) recession.

Here's Bespoke Investment Group yesterday on one of the reasons (the relative strength of the consumer) why we don't presently see all-out economic devastation on the near-term horizon:

"We note that the aggregate economy looks far more resilient than it did during either the COVID or 2007-2008 bear markets, with no major debt imbalance and strong household balance sheets."

That said, they do acknowledge the present disconnect between stock market valuations and the underlying fundamental trends:

"That said, there is lots of room to compress valuations in a round of equity selling that is relatively self-contained and driven by financial conditions.

• 17% of Russell 1000 market cap trades over 30x forward earnings, with another third trading at 20-30x; with risk free rates heading for 4%, the valuation picture looks increasingly vulnerable.

• Only 29% of the Russell 1000 by market cap trades under 15x P/E.

• As a thought experiment, we wondered what aggregate market cap of the Russell 1000 would look like if we capped P/Es at 30x among stocks with forward 12m estimated EPS.

That would take the market down 27% from current levels."

Allow me to vent for just a moment on politics...

Make no mistake folks, politics (highlight below) virtually always rules!

Here's research firm Variant Perception yesterday on coal:

"Coal is the ultimate cautionary tale for the demise of “sin”
commodities. Once the world’s most important fuel, it has faced decades of headwinds from technology (i.e. shale gas driving displacement) and social / regulatory backlash.

• The industry itself has seen numerous bankruptcies, with the collapse in lobbying spend reflective of the terminal decline.

• Yet, global coal consumption and production is still projected to remain stable until 2050 (top right chart from IEA world energy outlook), led by India and China.

• Coal is simple to transport and store, and provides a reliable source of baseload power when needed. Energy security has always been a major EM policy priority, and will become a top policy priority once again in DMs (especially given the on-going Russian-Ukraine war).

• Coal has remained prominent in Germany due to the continued influence of unions. The UK was able to phase out coal-fired generation completely due to weaker unions.

Source: IEA

My very cynical point (and, btw, I'm not advocating for one fuel source over another right here) is that the environment, wealth inequality, loan forgiveness, subsidies, tax incentives/disincentives, yada yada will get attention/action only if/when it's politically expedient to give it...

Now, beyond any and all frustration, cynicism, etc., our task at PWA is to see the world for what it is, to understand political incentives and, most importantly, constraints, across all regions of the world, and to protect and -- for lack of a better term -- exploit, within the context of portfolio management, accordingly.

There's a reason why a not-small percentage of our research budget these days is spent on political and geopolitical research...

Asian equities leaned red overnight, with 10 of the 16 markets we track closing lower.

Europe's leaning green so far morning, with 12 of the 19 bourses we follow trading up as I type.

US stocks are a bit mixed to start the session: Dow down 54 points (0.17%), SP500 up 0.13%, SP500 Equal Weight up 0.06%, Nasdaq 100 up 0.60%, Nasdaq Comp up 0.53%, Russell 2000 up 0.21%

The VIX sits at 25.92 down 1.11%.

Oil futures are down 2.37%, gold's down 0.73%, silver's down 2.10%, copper futures are down 1.77% and the ag complex (DBA) is down 0.48%.

The 10-year treasury is down (yield up) and the dollar is up 0.22%.

Among our 35 core positions (excluding options hedges, cash and short-term bond ETF), 17 -- led by Nokia, communication stocks, Dutch Bros, cyber security stocks (new position) and water stocks -- are in the green so far this morning. The losers are being led lower by energy stocks, silver, AMD, uranium miners and Brazil equities.

"Worryingly, instability is becoming more regular, more inclusive and deeper. These crises are systematic, not idiosyncratic. Their roots lie in the progressive maturity of Western capitalism relative to the financial underdevelopment of China and other Emerging Markets, and specifically with the shift from a capital-raising to a predominantly capital distribution-focused financial system.

This features inventive bankers and rapacious speculators, rather than economist Joseph Schumpeter’s emphasis on innovative industrial entrepreneurs, and it is coloured by periodic lurches between ever-greater regulation, followed 
by periods of sweeping deregulation."

--Howell, Michael J.. Capital Wars

Oof!!    emphasis mine...

Have a great day!
Marty