Joe Bunting
The valuation-driven sell-off in equities is hard to navigate when the bond yield at which the market needs to discount those valuations is so hard to determine.
The market is struggling to determine that bond yield because of an unusually complex mix of inputs and crosswinds in the global economy: is supply-side pandemic inflation transitory or persistent?
Is consumer demand post-pandemic re-opening or more cyclically sustained? Is the Russo-Ukraine war supply effect in the system yet? And what effect central bank tightening will have on the real economy is at least as elusive as it was for quantitative easing in the first place.
However, the guidance from central bankers should be of value as they strive to discern the dynamics of their respective economies and balance the need to bring down inflation, exit extreme policy accommodation, and yet still support enough growth.
The guidance from the ECB appears relatively upbeat in the face of the extreme regional threat to growth posed by war along their eastern borders. The guidance from the BoE is more downbeat.
The guidance from the US Federal Reserve, echoed by its individual members' briefings, should be offering markets some source of reassurance: that only so many interest rate moves seem necessary for the foreseeable future, and that markets' speculations of ever higher and ever more aggressive moves in rates in the coming meetings by implication are overdone.
This in turn means not so many interest rate moves can jeopardise the very strong economic growth there but rather tap it back to a more sustainable level for the medium-term – not too hot and not too cold, the soft landing.
At this point, the markets may be able to start working with an assumption for bond yields as a more reliable basis of equity valuations after this stormy sell-off. This will have implications too for currencies trading at multi-decade extremes – the holy trinity of bonds, equities and currencies finding some balance…soon?
In the meantime, the CAPE Shiller basis of US equity market valuation indicates that for the 'cyclically-adjusted' portion of the market, which might usefully exclude all members of the Nasdaq 100 that are also constituent in the S&P 500 (i.e not cyclical but secular higher growth), the PE may be considered a much more reasonable level.
This is reflected in the Endeavour Fund, where 45 percent of the equity allocation across cyclical and defensive sectors offers valuation at more like a multiple of 13, EPS growth of 8 percent and dividend yield of 3 perccent with substantial inflation resilience built in.
The 10 percent allocation to secular growth is now a lot cheaper year-to-date, but still historically relatively expensive with a PE around 30 but some pretty impressive growth expected of in the region of 20 percent for the next year or two still the consensus.
After a period of market losses it can be tempting to re-order the pieces in the puzzle but these losses have been relatively systematic and ordered – the highest of high valuations purged the most.
No matter how the fund managers consider it, Endeavour feels well-set for quite a range of possible outcomes amidst so much uncertainty. Year-to-date, fund holdings in the Defensive Strength function are more or less neutral, as are those in the Cyclical Leadership component too, happily outperforming both value-oriented and main market indices.
The weakness has been in the secular higher growth rate investments like Amazon and Google, and of course the longer-dated government bonds offering the all-important 'keel to the boat' for those systemic shocks to markets that can happen anytime, even in a rising interest rate environment.
Even the fixed rate bonds have outperformed the inflation-linked bonds, which is quite something when inflation is at its greatest risk to capital in almost four decades. There's a reasonable case to make that most of the worst may be over for those, at least for the time being, and can be increasingly relied upon for that counter balance in any multi-asset portfolio.
Joe Bunting is co-fund manager of Tellsons Endeavour Fund.
