The Usual Bearish Suspects

Among the responses to “Apocalypse Soon” was a reference to the “usual bearish suspects.”

We all have our ideas about who belongs in that lineup. In the half-dozen years I’ve been writing for public consumption, I assiduously avoided naming names. Over the next two or three weeks, I don’t expect it’ll matter. Because pretty much everybody is likely to become some kind of bear.

The Fed is dialed in, the dollar’s taking no prisoners and consensus is for higher US real yields. Liz Truss is rolling the dice on a financial crisis in the UK. Haruhiko Kuroda is risking a currency crisis in Japan. Europe has crises, plural. Vladimir Putin is annexing ~15% of Ukraine. The White House is warning the Kremlin about “catastrophic” consequences for Russia if he uses nuclear weapons. And US domestic politics is about to become even more contentious as the GOP embraces the right-most faction of the party out of perceived necessity ahead of the midterm elections.

That brief summary contains no hyperbole, no geopolitical bias and no partisan statements. All of it is fact. And none of it is good. The S&P came into the new week on the brink of the June lows. The bear is back (figure below). Not that it ever left.

I don’t think I’m being needlessly gloomy to suggest that things can get materially worse. The S&P is still trading on a 16x forward multiple. That’s barely below the 10-year rolling average and it certainly isn’t cheap.

BofA’s Michael Hartnett reiterated familiar talking points, and this is one case where I think repetition is warranted. This is history. In the textbook sense, not just in the sense that the world makes “history” every day, by definition. “The drivers of a high 21st century P/E are all reversing,” Hartnett said, in his latest. “QE, fiscal austerity, free movement of trade, free movement of people, free movement of capital [and] geopolitical peace” are all giving way to a “new regime of higher inflation,” he wrote.

For Hartnett, that means the “secular view” remains cash, commodities and volatility will outperform bonds and stocks. A 20th century P/E of 15x is “more credible,” he added. A 15x multiple on, say, $220 in earnings gets you S&P 3,300.

Note that credit is bleeding cash. Investment grade funds lost almost $5 billion over the latest weekly reporting period, according to Lipper’s data. It was the fifth straight week of outflows (figure below).

IG funds snapped a record-long exodus last month, but like everything else these days, it was a false dawn. Between IG and high yield, US corporate bond funds lost almost $7 billion over the past week.

“We say the inflation / rates / recession shocks aren’t over,” BofA remarked. When you throw in the ongoing rout in government bonds, which crescendoed Friday in the worst session ever for gilts, the implication is that the highs in credit spreads and the lows in stocks “aren’t yet in,” according to Hartnett.

“Risks to the outlook are skewed to the downside even after our forecast revision,” Goldman’s David Kostin, who on Friday slashed the bank’s year-end target for the S&P by 16%, warned. “In a recession, we forecast earnings will fall and the yield gap will widen, pushing the index to a trough of 3,150,” he went on to say. “In the event of a moderate recession, our top-down model indicates EPS would fall by 11% to $200.”

The familiar figure (above) gives you some historical context. If the S&P trades down to 3,150, it wouldn’t make 2022 an anomaly. Rather, it’d just make this an average recessionary bear market, even as such a decline would easily exceed the median.

As the new week dawned, Bloomberg ran headlines like “Stock Traders Brace for a Steeper Dive as Fed Ups Recession Fear” and “Financial Crisis Redux Looms in Asia as Major Currencies Crack.”

In Italy, as the polls closed, Giorgia Meloni looked poised to become prime minister. She’s a “hard-right leader of a party descended from post-Fascist roots… known for rhetorical crescendos, thundering timbre and ferocious speeches slamming gay-rights lobbies, European bureaucrats and illegal migrants,” as The New York Times put it. Her ascendance would put Italy in the hands of “a politician with a post-Fascist lineage” for the first time since World War II, the same election coverage noted. I doubt that’ll be good for the beleaguered euro.

It’s not just finance-focused web portals and media outlets trafficking in foreboding market headlines, by the way. The top story in the Washington Post‘s “Evening Edition” email newsletter was about the Fed. And the economy. And markets. The title: “Fed unsure of economy’s direction as Wall Street meltdown worsens.”

If you’re putting together a lineup of bears, everyone’s now a suspect.