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Stocks, Reflation Trade Due For ‘Deserved’ Break: Morgan’s Wilson Suggests
It's always interesting to observe the difference in cadence between the rates crowd and the equities crowd when it comes to the pro-cyclical rotation narrative.
Yes, 10-year yields did manage to claw their way through 1% this month and breakevens hit highs last seen in 2018. But generally speaking, bonds are more reluctant than stocks to price a sustainable shift.
The rates crowd will tell you that, as usual, bonds are "right." In this case, that generally means that while breakevens may have
A break would be fine, really.
I do wonder about how much a reduction in liquidity would hit the reflation trades, given what a small part of total market cap those represent. When the whole R2K has only about as much market cap as AAPL, it seems like money flow from the latter to the former could easily offset a reduction in overall money flow to stocks.
Slightly related, I was noodling over the implications of looking at EV multiples rather than the media-friendly PE multiple.
Suppose a cyclical stock has 2020 EV $4BN = 2020 equity $1BN + 2020 net debt $3BN. Suppose 2019 EBITDA/share was $2.00, 2020 was -$3.00, 2021 will be $1.00, 2022 $2.00, and 2023 $2.30. Suppose 2020 EV/forward 2021 EBITDA is elevated at 15X, and over the next year valuation declines so that 2021 EV/forward 2022 EBITDA is a more normal 10X. Then from 2020 to 2021, EV would rise by +33% (from 15X $1.00 X shares out to 10X $2.00 X shares out). Suppose 2021 net debt is still $3BN. Then 2021 EV would be $5.3BN ($4BN x 133%) and 2021 equity would be $2.3BN ($5.3BN – $3BN). That’s a +33% increase in EV but a +130% increase in equity value.
This is why when things are rolling over you hide in the names with the lowest debt, but when things are recovering you buy the names with the highest debt. High debt magnifies the moves in equity value. Assuming “high” doesn’t mean “unsurvivable”, and given junk bond yields and Yellen-Powell at the reins, that’s not a difficult assumption.