So what's an investor to do with what they saw this week?
A lot of turmoil. No doubt about it, David, and strong
payroll data makes the Fed job much more difficult.
This labor supply shortage situation is quite concerning.
So it looks as if the Fed is going to have to continue raising rates.
And this creates a tremendous headwind for the U.S.
market and for markets around the world where central banks have to move up is
not in lockstep with the Fed. They, too, have to be tightening in
order to quell inflation that is global. I I wonder, did Jay Powell get us ready
for this to some extent? I'm assuming he didn't have any idea
what the number is going to look like, but he sort of warned this on Wednesday
what they're gonna have to do. When we think of this number, though, I
don't think we have as pessimistic view and as pessimistic or read.
In fact, you could see what happened to the market today at the end of the day.
And you could say, in fact, the market's probably saying it's not as bad a number
from a tightening in a recession perspective.
So, in fact, our view is that if you look at the non-farm payroll numbers at
the beginning of the year, they were averaging over three months, about six
hundred. The last three months now are about two
hundred ninety thousand. So that's nearly half of what, more than
half. So that's a significant slowdown in the
economy that we're seeing. And then if you look at the average
hourly earnings and you look at what the latest three numbers are, about three
point nine percent, the prior three months, it was 5.2.
So directionally between what the Fed has been doing and generally financial
conditions in the United States, things are slowing down and it's not
insignificant. So the question is, how much does the
Fed need to tighten to lower those numbers even further?
And our view is that they do have more to go.
But I'm not sure the idea that it's definitive they have to go to 5 percent
or 5 and a quarter. It's not so obvious to us.
At the same time, are the markets fully describing charming, using what the Fed
is going to have to do? Because as you say, they're going to do
a lot more. As Jay Powell said he was.
But to the markets, get that, obviously, I think the markets if you
look at the pricing on the tenure, if you look at what's happening in the
short end of the curve, and if you look at the market volatility that we're
seeing in the equity market, we do think the market, the markets do understand
the uncertainty of that. We actually encourage our clients to
think about the recession probabilities with a very open mind.
We have two incredible economists, great experience.
One is Bill Dudley, former partner at Goldman Sachs, our chief economist, and
he became head of the Federal Reserve Bank of New York and vice chair of the
FOMC. He has a 70 percent probability of
recession. And then you look at John Hatzius, our
current partner and chief economist, and he has 35 percent.
So that tells you that we should think about recession as a 50/50 probability.
We may have a recession. We may not.
And our view is the market is priced priced to that, that the market is
already saying the odds of a recession are very high.
What about it, Sara? Is the market discounting already a fair
amount of a recession? I mean, actually, so the numbers suggest
that if not all of it, a fair amount is already priced in.
That's very tough to say, David. What we do know is they lag in effect,
as the Fed is pointing out, in our economy wide.
In fact, there are global and more more companies we speak to.
You are talking about sales are holding up.
They have some serious cost pressures and that they're just seeing this
beginning of demand starting to turn down across industries.
So it looks to us like it's early days for what may be happening to earnings.
And it's only when earnings, bottom markets begin to really anticipate the
recovery if earnings continue to be revised downward.
We're in for a pretty tough period. And the higher higher interest rates go
clearly, the more pressure, downward pressure on earnings multiples, which
again, is not this is not helpful from an investment perspective.
Charming. What is your view actually on where we
are compared to, for example, emerging markets or compared to China?
Our market is our market already discounted more?
Our view is that the equity market has actually discounted a lot.
If you go back and look at past recessions on average, the median and we
look at the media because you don't want, for example, really extreme
numbers to be pulling down the market. So if you look at the median on average,
it's down about 24 percent. Then you look at the average numbers,
it's around 30 and high to low. The S&P 500 has actually been down about
25 percent. So to say it's not discounting a
recession seems a little bit of a stretch to us.
Our view is it has already discounted a bit of a recession.
And then the next question becomes, if we do have a recession, how much further
could it go? Could it be down another 5 to 10
percent? Yes.
But we do think a fair amount has already been discounted.
The other thing to keep in mind is the equity market usually actually rallies
before the trough and earnings usually about by about six plus months.
So we don't actually have to see the big downdraft this year as a time to go back
into bonds. I wouldn't if we think rates are going
to continue to rise, but we really equity specialists.
And if it's interesting and interesting, what Charmin has to say about markets in
aggregate start to desegregate. And there is a fascinating push and pull
now globally, in particular in the U.S. between what's happening in the more
defensive sectors. Let's take energy aside.
But those that are less economically sensitive versus those that are very
economically sensitive, and we think one of the biggest decisions that investors
are going to need to make over the next 12 to 18 months is wind and make that
shift and feel one way to think about this is just start now and do it very
gradually because we just don't know where.
Mark, we could talk about it all day long, but we have no idea where markets
will actually bottom. But in out of recession or out of
economic slowing, the best performers typically are the more cyclical stocks
or those cyclical sectors. And it's getting from the defensives to
the cyclicals. That is the critical journey in this
market. Sara, one of the things we have found is
that when you've had a big downdraft in the market, for example, if equities are
down 20 percent, usually the next 12 months on average, equities are up about
23 percent. And if you look forward, two years,
equities are actually up over 30 percent.
Now, this is the S&P broadly. And obviously when you look at the
sector dispersion, that's been quite significant this year.
As you point out, energy's up 70 percent.
You look at sort of technology and other sectors
down 20, 30 percent. So clearly huge dispersion.
But in aggregate, the equity market tends to rally after such a big
downdraft. So does it make sense actually, for
investors to start getting more aggressive with their portfolios?
Well, this is really hard to say, not knowing investors risk tolerances.
But to my point earlier, I just again, we can't know the bottom.
It's true of us as equity analysts and portfolio managers, we never know where
a stock's going to bottom and therefore we accumulate early.
And then we also we get quite a bit as much of the stocks we can, as low as
we can in the average entry price is usually very attractive and that creates
a lot of room to make money on the way up.
And I think that same analogy applies to broad markets.
So there are ways of working one's way to getting access to different markets
around the world, especially emerging, and are actually on their backs relative
to developed. But they're all at multiples now that
are beginning to look more attractive as long as earnings don't collapse.
And that's the big if.