November Market Multiples Table: Fed Tapering And Rate Hikes Are, By Far, The Two Outsized Influence
There were some notable changes to the Market Multiple Table in November as we received at least partial clarity on several macro issues, but in the end this month’s edition of the MMT demonstrates two simple truths about this market. First, it’s largely priced to perfection. Second, how the Fed removes accommodation (tapering and rate hikes) is, by far, the biggest potential influence on markets in the coming months.
Market influences in the MMT are ranked from the strongest (at the top) to weakest (at the bottom) and for this month’s edition I wish I could have put a larger space between “Fed Tapering Pace” and “First Rate Hike” and the other two influences, because Fed tapering and rate hikes are, by far, the two outsized influences on stocks right now. Yes, if we get a wildcard from Washington on the spending package (so surprise tax hikes or cuts) that would impact stocks, and if yields start spiking higher that could be a headwind. But both of those scenarios are unlikely right now.
Instead, it’s all about the Fed and whether they remove accommodation at the pace the market expects, and hike rates when the market wants them to. Finally, I don’t have “Inflation” as a market influence because inflation only matters if it causes the Fed to get more hawkish. So, inflation is only important as it relates to the Fed right now, and that’s why we included the Fed as an influence, not inflation.
Hawkish: words used that indicate increasing inflation, higher interest rates and strong economic growth lean towards a more hawkish monetary policy outcome.
Regarding valuations, the MMT reflects the reality that stocks are priced for relative perfection. And while markets trading above 20X hasn’t proved sustainable in the past, given the relative macro-economic calm and the prevalence of the TINA trade (There Is No Alternative to Stocks) combined with seasonality, valuations alone won’t be enough to pause the rally—although I do want to highlight that like in September, the market is easily 3%-5% above any sort of defensible valuation level (meaning that’s the minimum we’d expect from a pullback).
Current Situation. The current situation reflects the partially positive developments over the past month, as markets know that tapering will be $15 billion/month through year end, and Fed officials are reiterating a late-2022 target for rate hikes. Additionally, Democrats seem to be on the way to passing a $1.75 trillion dollar spending bill that includes no notable tax hikes and, possibly, a tax cut via the reinstating of the SALT deduction. Finally, yields have backed off recent highs and are digesting high inflation and strong growth well.
But despite that progress we still have concerns about valuations here, because while the current situation is positive it’s also more than priced in at this point, which again leaves markets vulnerable to an “air pocket” if there’s a negative surprise from the Fed, Washington or another surge in COVID.
Things Get Better If: The Fed Confirms Tapering Will Be $15 Billion/month for the Duration, The First Rate Hike Won’t Come until December 2022, Democrats Pass the Spending Bill with SALT Limits Removed and Yields Don’t Rise Too Quickly. This would essentially be the “best case” scenario for stocks in that markets would have clarity on tapering and, more importantly, rate hikes. Additionally, the economy would get extra stimulus via spending and the tax cut, and yields don’t rise so quickly that they pressure multiples. This scenario would lift S&P 500 earnings expectations for 2022 to as high as $225 and a combination of the very, very slow taper and extra fiscal stimulus could push the market multiple out above 20X, meaning the best-case scenario for the S&P 500 would be in the mid-to-upper 4,000s. The only problem is markets have already largely priced in this scenario (but it hasn’t actually happened yet).
Things Get Worse If: The Fed Hints at A Faster Tapering of QE or A Sooner Than Expected Rate Hike, Democrats Put Corporate or Personal Tax Hikes in the Spending Bill, or Yields Start to Rise Sharply. If we get a more-aggressive-than-expected Fed (via tapering or expected rate hikes) then markets will get more volatile as the last several percentage points higher have been driven by momentum triggered by Fed clarity. Regarding tax hikes, anything that could hit expected S&P 500 earnings would be a new headwind, and if yields started to rise sharply that would pressure the market multiple.
The MMT reflects the fact that the outlook for stocks has improved over the past two to three months. But in part because of momentum and the TINA trade, stocks have rallied beyond the “fair value” of that improvement and once again are trading as though a “best-case” scenario is now the current situation (the farther we go, the farther we'll fall). Certainly, that could end up being the case. But that also leaves this market vulnerable to a September/October type pull-back, if we get surprise disappointments from the Fed, Washington or with Treasury yields.
And remember – the one fact pertaining to all conditions is that they will change.
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President