Mon. Dec 6th, 2021

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We come to that time when journalists write summaries of the dying year and previews of the one about to be born – this is a step-back-and-look-at-the-big-picture season . What should Unhedged take a step back and look at? Email your thoughts to me at or to Ethan at

Too happy holidays

I’m not really sure what makes the market go up or down, which is an embarrassment, because I’ve been thinking about it for something like 17 years professionally, on and off, about it. But it seems to be helping the market to rise, or at least not fall, when:

  • corporate earnings rise, ideally at an accelerating pace

  • companies buy back many of their own shares

  • there is a lot of cash flowing around the economy

  • there is still a significant minority of pessimists around who can be converted into buyers, through good news or simple capitulation

The problem with these four interrelated factors is that they are not much of an alert system. They are all true, and then none of them, or vice versa, at what point the market is far ahead of you. But it still seems worthwhile, as we take towards the end of the year, to see how we fare in each area.

According to FactSet, S&P 500 companies reported 40 percent earnings growth from a year ago. That’s a big number, but who cares. This is largely due to the reopening and energy prices. What matters is how much earnings will grow next year. The current estimate for 2022 is about 8 percent earnings growth, which is good if not great by historical standards. What worries me a bit is that the estimates place most of the growth in the back half of 2022. In the next few quarters, those that analysts can see most clearly, successive earnings growth is not expected to be as large. A graph of FactSet’s useful earnings insight blog:

Repurchases are absolutely flourishing. In the third quarter, according to Howard Silverblatt of S&P Dow Jones Indices, S&P 500 companies repurchased $ 225 billion of their own shares, beating the Q4 2018 record. The rate of buybacks has now picked up for 5 quarters. It seems to me like a big buyback for US stocks, although, as Howard notes, stocks are so expensive that as a percentage of the market’s value the Q3 buybacks, at about 0.6 percent, are well below the average of the last was. decade.

Liquidity, measured as balance sheet expansion at the major central banks, grew at a steady pace, slightly below 10 per cent. Here is a graph of transboundary capital:

It seems to be okay, but in the US and Europe slimming is coming. What happens then? On the other hand, China could relax its policy if the real estate market there continues to degenerate.

Much of the money that central banks impress in the system still finds its way into equities, but according to BofA, on a slightly accelerated pace over the past few weeks:

The last factor, sentiment, is the only one that really looks really bad. Below is Citigroup’s Levkovich fear / euphoria index, which is based on a bunch of things like short interest, margin debt and the put / call ratio. It is far above in euphoria area, at a level that has reliably predicted poor returns in the past. To use a tired Wall Street cliché, there is no wall of concern for stocks to climb:

A particularly sad example of this comes from Bank of America’s fund manager’s survey. Managers (unlike the punditocracy) are increasingly confident that inflation is transient:

I think I may be the last expert in the English-speaking world without a firm view on what inflation is likely to do (I found both sides of Chris Giles excellent recording equally convincing). But I’m sure I’ll be happier about the market outlook if I think fund managers are more afraid of it.

Overall Thanksgiving week scorecard: market is high and expensive, but earnings support, buybacks and liquidity seem solid (if not perfect). Sentiment levels, however, are frightening.

Back to the UK

Several readers have pushed back the argument from Friday’s letter that British shares will be deducted by British labor shortages. The argument was that the deficits, in part as a result of Brexit, would become an obstacle to profit growth and valuations at UK companies, as it would exacerbate the national mix of growth versus inflation.

The objection was that the FTSE 100 is basically an index of large-cap global companies, and that local labor issues will not matter much to its performance.

I put this objection to Ian Harnett of Absolute Strategy Research as it was his argument to begin with. He pointed out to me that UK equities returns have historically matched UK GDP growth, despite the global character of its largest listed companies. But this is probably due to the fact that British GDP follows global GDP – Britain is a small, very open economy.

But the crucial point is that ASR’s argument takes the position of global investors, and that the British macroeconomic dynamics describing the argument are likely to drag on the pound. From a global investor’s point of view, this will create a barrier to FTSE 100 returns unless the currency is hedged. So perhaps the best reading of the argument is: hedge the pound.

The argument can also be simply reformed as an argument for the shorting of the FTSE 250, which is a mid-cap index that has generated about half its domestic revenue, compared to about a quarter for the FTSE 100. And it has another appeal: unlike the FTSE 100, the 250 does not look historically cheap compared to its American cousin, the S&P 400 middle capitalization. On the contrary, the British middle capitalization is historically at about a 20 percent discount to American middle capitalization, in price / earnings terms. Now they are close to parity, according to Bloomberg data.

A good read

I was gripped by this New Yorker piece on forensic genealogy – a technique that captures many killers that seemed inconceivable.

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