The Credit Strategist May 2022
“I couldn’t stand it. I still can’t stand it. I can’t stand the way things are. I cannot tolerate this age. What is more, I won’t. That was my discovery: that I didn’t have to.”
Walker Percy, Lancelot
The bullish case for stocks requires investors to overlook Fed tightening, the highest inflation in forty years, severe geopolitical instability, and tough corporate earnings comparisons. Societe Generale’s Andrew Lapthorne writes: “Equities are priced on cash flows discounted by a bond yield and an equity risk premium. Currently, cash flow expectations (excluding the commodity related sectors) are being cut, bond yields are rising rapidly, and heightened political risk implies higher risk premiums. That’s not so much a headwind as it is a full-blown gale, and it has pushed equity markets back down towards their March lows, with the US equity markets, and the Nasdaq in particular, leading the way.” The usual suspects in the media and on Wall Street are working overtime to minimize these headwinds but markets know better. If you are surprised or unprepared for what is happening, you really have no business managing your own or anybody else’s money.
The only surprising aspect of this market sell-off is that it didn’t happen sooner but perhaps that can be chalked up to the Fed continuing QE until early March. But that game is over (for now) and we are operating in an entirely new environment from the one that existed over the last dozen years – one in which inflation must be addressed for both economic and political reasons and can no longer be stuffed under the rug. As Figure 1 on the previous page shows, we can measure progress (if we want to call it that) by the fact that trillions of dollars of negative nominal yielding corporate debt is now trading at merely negative real yields. So bond investors have jumped from the frying pan and into the fire while equity investors are walking on burning coals in bare feet, reinforcing the lesson that there are no free lunches in financial markets. What markets give with one hand they take away with the other. We are all on the clock, in markets as in life.