January Market Multiples Table - Kurt S. Altrichter
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The influences on this market consolidated in the January Market Multiple Table, which is positive as it’s fewer factors to keep track of, but the overall message of the Market Multiple Table is the same as December: This market has been very good at ignoring disappointment, but at this point it’s priced well above “fair value” and if there is legitimate disappointment the market can’t ignore, it’s a long way down to fundamental support.
From a market influence standpoint, the December Fed meeting essentially revealed tightening plans, so the key Fed related influence on markets went from both Tapering and Rate Hike Expectations in the December Market Multiple Table to just “Fed Tightening,” as it’s now a matter of when, not if, the Fed ends QE and rates rise.
Inflation is now a market influence on its own because it’s the main contributor to Fed hawkishness or dovishness (but not the only one as growth and employment also are pushing the Fed to reduce accommodation). Markets are going to need to see a substantial moderation of inflation in the coming months if the Fed is going to back off its newfound hawkishness.
Finally, Omicron remains an influence on the markets. Thankfully, Omicron did not render the vaccines or boosters ineffective (especially against severe illness). At the same time, though, Omicron cases are exploding around the U.S. and the globe, and as such the sheer number of cases carries with it the risk of forced shut-downs or current shutdowns that could temporarily hurt growth but not enough to make the Fed back off its hawkish outlook.
Looking more broadly at the January MMT, one of the biggest takeaways is that the “Gets Better If” scenario really doesn’t result in that much more up-side in stocks from here. But any sort of legitimate disappointment means, at minimum, a 5%-10% air pocket, and likely more than that before any sort of fundamental valuation argument can be made. And while that reality isn’t enough to de-risk, I do want everyone to be aware of it, because we’re looking at a market with not a ton of upside and a lot of downside if something goes materially wrong.
Current Situation. The Fed decision in December met market expectations in tapering but was more hawkish than expected on rate hikes (three vs. the expected two) but markets were able to digest that thanks to some dovish soothing from Fed Chair Powell. But that does leave the possibility the Fed gets more aggressive, and a rate hike before June would likely be a headwind on markets.
Inflation has started to show some signs of plateauing, although Omicron supply chain disruptions threaten to extend the period of higher inflation. But almost more important than actual inflation stats is the perception of inflation and right now it’s public enemy No. 1 from a political and consumer standpoint. High inflation for regular goods tops most peoples’ list of concerns about the economy, and for inflation to stop being a hawkish influence on the Fed that will need to change soon.
Finally, Omicron is raging across the globe with more than 1 million new cases in the U.S. on Monday, but hospitalizations remain low, and governments are not employing lockdowns yet. And as long as that’s the case and, as expected, Omicron peaks in the next few weeks, it shouldn’t be a lasting negative influence on the economy or the markets (although the sheer number of cases along with worker shortages, etc. is a potential problem that needs to be watched).
Bottom line, the “Current Situation,” in an absolute sense, really isn’t that great, as the Fed is clearly tightening, inflation remains high, and Omicron is raging. But markets have learned that taking the optimistic view has worked over the past few years, and the only way stocks justify these multiples is the idea that 1) The Fed doesn’t tighten too much, 2) Inflation peaks and 3) Omicron fades, because the actual current reality doesn’t justify these valuations or levels, and that’s something to think about.
Things Get Better If: The Fed Hints It Might Not Hike Three Times in 2022, Inflation Peaks Not Just Statistically but Also As a Focus of Washington, and We Don’t Have Omicron Shutdowns. This would largely validate current valuations as it’d remove the risk of the Fed overtightening (at least near term), while at the same time shifting the focus away from inflation (and easing the political pressure on the Fed to get more aggressive). Additionally, as long as hospitalizations remain comparatively low, Omicron shouldn’t be an issue for stocks. This scenario would produce a slight rally in stocks, but it would essentially validate current levels from a valuation/fundamentals standpoint.
Things Get Worse If: The Fed Hints There Could Be Rate Hikes Before June or Four Hikes in 2022, Inflation Stays High Both Statistically and as a Focus of Washington, and Omicron Cases Rise to Levels That Require Temporary Lock-downs, Hurting Growth. Normally, I can say that most of the “Gets Worse If” scenarios are very unlikely, but this month, I’m afraid I can only say they are somewhat unlikely. Case in point, if inflation stays high (meaning CPI is hot) then that will put additional pressure on the Fed to hike even more in 2022. And while that won’t be decided in January, the Fed could at least allude to that possibility at the January 26 meeting. Finally, regarding Omicron, it is very unlikely that the number of cases results in lockdowns, but it’s possible that people change behavior and that puts a temporary headwind on growth, although thankfully that doesn’t appear to be happening, at least not yet.
Bottom line, the Current Situation simply isn’t as good as the S&P 500 valuation would imply but markets are forecasting tools, and clearly investors are forecasting that the Fed won’t be too hawkish, inflation will peak, and Omicron won’t be a headwind on growth—an optimistic path that has been right since March 2020. But if the market is wrong stocks could easily hit a 5%-to-10% air pocket if not more. And while I think that’d likely be a buying opportunity, suffering that type of loss early in the year might spook some of you. If that is a concern, then you might think about rotating to some lower-volatility ETFs or funds might make sense until there’s more clarity on the Fed, inflation and Omicron.
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President