I love Warren Buffet’s wonderfully simple idea that there are just two basic emotions in the stock market, greed and fear. The temporary dominance of greed creates bubbles, and when fear has the upper hand, we get crashes.
In times of uncertainty, markets can flip between the two very quickly depending on short-term news flow. Sometimes the focus will be on imminent triumph, sometimes impending disaster. The reaction to the apparent arrival of these two imposters is usually just the same. Strong and over-done.
Just look at the US market. The S&P fell 16.4% in Q2 as fear took hold. But the third quarter has thus far seen an about-turn. Investors have flipped to become very greedy and have pushed the same index up 11.7% so far in Q3.
The initial catalyst for Q2’s move was the effect runaway inflation could have on interest rates. Since then, half year numbers have provided some cheer. With the significant majority of the S&P 500 having reported, data from Factset imply 75% of its constituents reported earnings ahead of expectations. Strangely, that’s about par – which tells us that US analysts are generally wrong most of the time. More importantly though, against the backdrop of such violent declines, resilient results reassured those with fingers hovering above the ‘sell’ button.
While corporate results were robust, the argument that the US is approaching ‘peak inflation’ quicker than expected gained traction with many. This has been another tailwind for markets. Of course, lower inflation means a stronger consumer, but it also means lower interest rates, all else being equal. As a result, expectations for where the base rate settles by the end of next year are now not quite so great. Jerome Powell could well play scrouge in his speech at Jackson Hole this week, but he may artfully dodge around the issue. After all, there is another inflation print due before the September meeting.
When compared to the UK, it is a tale of two very different monetary policy committees. Peak inflation feels some time ahead of us yet and interest rate expectations are being cranked up. The Bank of England may be forced to increase rates to 4% next year. That’s miles ahead of where consensus was just a few weeks ago.
Against that backdrop the fact that the UK market has held up well may appear quite surprising. There are several contributing reasons for the resilience. Like the US, results have been strong. In particular, the banks (which of course benefit from higher rates) have stood out. Then there’s the fact that much of the upwards pressure on inflation has been from the spike in oil and gas prices. That has only helped those two heavyweight bruisers BP and Shell generate higher profits. They, along with many other multi-nationals, are also getting a boost from the apathy towards the UK economy that has caused Sterling to weaken.
I finish this market round-up with a quick word on China. It has been quite a rollercoaster recently. The MSCI China index outperformed global equities by almost 20% in Q2, but Q3 has seen it come crashing back down to earth in almost a mirror image of what’s happened in America. Covid remains a major headwind. The latest data show nearly 2,200 new cases, a three-month high, which has again led to localized lockdowns. Relations with the West over Taiwan are also a concern.
When markets are moving up and down by such large amounts, it is both difficult and dangerous to say with certainty what is next. I am conscious that while results in Q2 were solid, full year forecasts for 2022 and 2023 are being revised down in the US. That could put pressure on valuations. European companies’ earnings are not being revised to the same extent and valuations are already less demanding, but the threat of Russian gas being switched off looms large as winter approaches. Chinese policy, both internal and international, remains hard to predict. But at least there is the prospect of dovish monetary policy there. As far as the UK goes, it is not clear whether markets will predominantly see Liz Truss’ tax cuts as economically stimulative, or as adding fuel to the inflationary fire. That’s assuming there’s not a major upset in the race to be PM.
All this means short-term predictions are arguably more difficult than ever. But really that has always been a mug’s game. One thing I would hang my hat on is that markets will remain very good at generating long-term wealth. Timing can be difficult, but if we apply Buffet’s logic it is likely that the seeds that generate the best returns will be sown when it feels least comfortable to invest.
This week’s question concerns football. Manchester United officially became a joke both on and off the pitch when Elon Musk was recently forced to clarify a tweet saying he’d buy the club was very much tongue-in-cheek. Including results from last season, they have now lost seven consecutive away league fixtures. When was the last time this happened?
George Salmon – Senior Investment Analyst
All charts and data sourced from FactSet
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