October 2022 Video Market Update

Hello, everyone and welcome to my market update. We meet at a very interesting time for the markets, and a very important time. So I've gathered together here all the most important slides and images of things that are happening in the market that are crossing my desk. Now, as a hedge fund manager, as you can imagine, I get a lot of data from investment banks, from other hedge funds, from analysts, from brokers on my team who work for me. It's their job to collate these and show me which ones are the most important. And then it's my job to summarize these for you guys.

So look, in no particular order, US mortgage rates soaring to the highest level since 2007. We've got the same problem in the UK. That's a reflection, really, of what's happening in the bond market. And the bond market is a reflection of global confidence in the macro economy of the US. Now you might say, "Wait a minute, people are buying dollars. Surely they're confident in the US." Yes they are, but they also know they can get away with selling bonds, pushing up the yields. And we also know due to quantitative tightening that that's happening as well. And people want to get out before the Fed starts selling those bonds at ever larger numbers. So they're just anticipating what's going to happen. And of course, after easing, we knew tightening was coming. In other words, the bonds were going to be sold by the government. Well, it's happening and mortgage rates are going up.

That's going to be a problem. That's going to be a problem. It's going to be a problem for consumer spending. It's going to be a problem for a large chunk of the stock market. However, it's going to present some opportunities as well.

One of those opportunities that it's going to present is depicted by this image. The S&P 500 stocks are becoming less expensive compared to their profits. In other words, forward price to earnings ratio. There are multiples that we've seen really during the plunge of Covid. And that is where the opportunity comes in. What will happen is there will be panic to the downside and an opportunity to buy in pocket some specific stocks. And that's where I come in. It's where our research comes in.

Okay, what else did I notice which I think is worth mentioning? Well, the other thing was you can certainly expect with the higher cost of borrowing, rising interest rates being one of those things leading to a higher cost of borrowing plus a tight labor market, which means wage inflation against a higher cost to businesses, that there'll be slow down in profit growth. Now profits have been growing and growing and growing. Those good days are pretty much over. Margins are being squeezed after margins. You get losses, margins turning negative. Now, it's not going to happen across the board, but it will happen to an ever increasing number of companies. And what that means is that the gene pool of companies we can pick from, which we anticipate giving us stellar returns narrows. In a bull market, you can throw a dart at a dart board, everything hits and wins. In this kind of a market, you're going to have to be a lot more particular, more specific. And that's our job is to do that.

One thing that we also know is that when these kinds of values have been erased, some $32 trillion wiped out over global stocks. So it's not just an American phenomenon, it's a global phenomenon. When we see these kinds of things happening, those values that have come down means there are certain things which are going to be cheaper, and that's what we want. We want to make some deals with some stocks which are going to be cheaper.

And let's take a broader view of the pyramid of equity returns. We're sitting here. We're sitting in those very few years, which show between a minus 10 to a minus 20% return. We might end up in those very, very few years. And this is just to show how rare it is to have negative returns. They do happen. So we shouldn't be surprised. This year will probably be a negative year. Equally, we know that next year may well be, just statistically and probabilistically, a more positive year. So I'm trying to give some positivity there on that.

This is an old image from Goldman Sachs that I want to draw again. It's about a year old and it was their analysis of what tends to happen, average returns and length of the S&P one year before and during a bear market. And you get this, and this is pretty much what's happened this year. Massive rally up, going to fall back, and then you get a bear market rally, and there you go. You could almost say this was January the first where the market hit an all-time high, then fell, and we got a bit of a rally back in, what was that? August, September time before falling back again how long will it last? Well, bear market's meant to be minus 32%. We're not there yet. And I'll show you a chart in a second why I think we've still got maybe even another negative 10% to go, if not more. I don't want to say it. I don't want to say that, but I've got to say it. The number of days which that could happen from where we are now, well it could be another, not quite a whole year to go, but there could be a few more months to go of falling markets. So we're going to poise ourself and just pick, do strategic strikes on individual stocks, pick out the very best ones.

We don't have to pick the whole market. That's the advantage we have. Now let's get the S&P 500 index returns from the hundredth trading day until the end of the year. Now we're well past the hundredth trading day, but it does show that even when you start off relatively negative and the hundredth trading day in 2022, we were down 16 and a half percent. And in the past you ended up return for the rest of the year, the rest of the year had been quite positive. Now we're just into October. Does that mean October, November, December could have a big turnaround and give us quite a bit of a rise up? It'd have to be, if it was going to be positive, it would have to give us about a 25% return from where we are now. I don't think that's actually going to happen, I'm afraid. Okay, so as with all records, they're there to be broken. I don't think we're going to go up 25% from where we are now in order to get a positive return for the year.

But then again, don't forget what this is actually measuring is not the return for the whole of the year, but a positive return for that rest of the year from the hundredth day. Now there you'd only need the market to have risen from where it is today in October when I'm speaking to, you probably have risen, I don't know about 10% from now till the end of the year for that number to be positive. Now there, if you were to ask me, are we likely to be higher or lower by the end of the year, I'd say it's probably as much chance we're going to be higher as from where we are today to we're going to be lower. And this is one of the reasons why. So I don't think it's going to be a straight short market all the way down to the end of the year.

What's been doing well? Well, as you know, I don't look top down. I don't look at sectors first and then work my way down. I take that information in, but I actually look bottom up. In other words, I look at the individual companies for their valuation, their growth, their income, GVI growth, value income, and sortino, and cash flow, croaky, volatility, momentum, all of those other factors. Just so happens a lot of those ticking those boxes happen to be energy stocks.

Equally, I wanted to show you this, which is interesting from Bloomberg. And what it shows is the percentage change in stock prices based on their certain characteristics. So if you went for high dividend stocks there down seven and a half percent, growth stocks down 22%, value stocks, 17.8% and so on and so forth. And this was produced at a time when the S&P 500 was down 16.1%.

Of course, it's down a bit lower than that now. The point of this is to say we don't gamble as both a hedge fund and also for the GVI newsletter that I gave you, we don't try and gamble on, oh, is it this year going to be high dividend, or is it going to be minimum volatility, or is it going to be dividend growth, or price momentum, or size, or S&P 500 companies, or quality, or value, or growth?

We look to tick all those boxes. The reason being, if we tick all those boxes and make sure, well if it's a growth stock, let's take an extra example, which is also a high dividend stock. Then what it means is any of those growth stocks which are not high dividend stocks, we won't be picking. So we won't be down 22 and a half percent because we didn't pick only on growth. We picked on growth and high dividend and that's a narrower subset, which is high dividend stocks. So we should not do as badly as the rest of the market in that we should hopefully do better than the market. In any event, in absolute terms, we should get an absolute positive return. But if everything's falling then we shouldn't certainly fall as far as everything else for the reasons that I just mentioned, that we look to tick every box. I wanted to show you that. And I think it's important. We're not unlike many funds, gambling on what's the flavor of the month.

Now, why is inflation and the control of inflation so important? You might say, "Well why don't we just let a bit of inflation run?" And you might as well. I know a lot of inflation's bad for purchasing power and so on. Well this shows you how bad. So if you'll start with a hundred K after eight years, you are left with 47,000 in purchasing power, if inflation remains at 9%, and it's currently at around 9%. This is why in eight years you've halved, actually after about seven years you've pretty much halved you are purchasing power. That's why the banks are so keen, the Federal Reserve is so keen to get a grip on it.

So where are we on the S&P 500? And I want to show you this image and what I think as things happen is the most likely scenario, so we're around here. Okay, I've shown you that. It previously dropped 22% to get to there, and we're sort of around that mark. And if I was being optimistic or mildly pessimistic, I'd say we've got another 5% to go, and that'll take us to about here in this downward channel that I've drawn.

And if I was being more pessimistic, I would say we're probably going to go closer to there, which is another 15% lower in the next six months. Now these things tend not to happen in a straight line. What tends to happen is they could even go like that and then like that. It could take any journey you can imagine. So there's a lot of alternatives there.

Now let's go to the next chart, which caught my eye. This one's from Goldman Sachs. Stronger dollar is correlated with fewer revenue beats. So in a way it's another way of saying profit margins will be under pressure, but there's another reason why profit margins will be under pressure. The dollar is at record levels against many currencies. The yen for one and the sterling British pound for another. That's going to hit American company's ability to beat their revenues. So just so you know it, you have a strong dollar. Yay, we're strong. The word strong sounds great. Actually the data suggests companies are going to get a little bit hurt. Stocks are going to get a little bit hurt.

So let's go forward also with, I'll try and give you some positive news again. S&P 500 returns after falling 20% from record high since 1950. And we've fallen, as you know, 20% from the record high. What are the returns one year later, six months later? Well let's say from now, because we're at that level now, what can we expect six months from now? Well the average is 4% up and that's positive 60% of the time. A year later, 15%, two years, 26%, three years, 29%. Okay. Look, it's just data. The hit the past does not guarantee the future. So pinch your salt on this, but overall, as you can see from where we are today in six months, one year, two year, we should have a tailwind from today. We should have a tailwind. We should be getting to turn things around.

That means it's probably a good time to start picking one or two of those individual stocks, but it's not going to be the same tailwind as we've had for the last few years. It won't be tech. I really don't think it'll likely be tech, because what we've found is when you've got below trend GDP growth as we have at the moment and high end rising inflation, it's more likely to be energy. That's where we are. It's more likely to be energy. All right, than it is to be tech. Tech tends to be minus 17.9%. Now we don't care, because we're not attached necessarily to tech, we're attached to returns and tech happened to give those. But if somebody else is giving them, we will go to them.

This is from the investment bank Jeffries, which I thought was quite interesting. What this shows is defensive stocks to own during stagflation-like periods. That's where you've got inflation low growth. And these are their names that they've come out with. And I'll tell you which one's out of these that I did like and sort of crossed my bar when I do my weekly updates, because very often none do. And when I do my bellwether stocks and when companies like this investment bank, Jeffries, mentioned companies over and over again like Johnson & Johnson and Goldman Sachs mentioned, others mention it. The reason I look at it is because it's clearly become bellwether, a kind of guide for the rest of the market. And so I need to say to you guys, well actually this is what's going to happen. The bank's wrong, and they so often are, and this is actually what's going to happen. But anyway, this is what they think and this is what they believe is the monthly average out-performance during stagflation since 2000.

Well that's their data. What I can tell you when I give that weekly update from my GVI research newsletter is more specifically what's happening with some of the energy companies and the big names that you've all heard of like Johnson & Johnson. And it's often not looking like these numbers at all, because these are just historical numbers and an average and history doesn't guarantee the future. So you might see data like this, but that's why you also want to see what I think on the GVI newsletter because we're able to show what's really going on with the chart and say that what's happening this time round.

You'll also see these, and I quite find these interesting, this is from Bloomberg. Market time, it can be costly if you'd invested all days hypothetical $10,000 in the S&P from 1980 to 2022. What if you miss the best five days? Obviously nobody ever just misses the best five days. Yeah, if they miss the best five days, they probably also miss some of the worst days as well. So this is a bit of a cheat. It sort of scares people in thinking, "Oh God, I better not do anything better, not exit any stocks and just stay in, because tomorrow might be one of the best days ever." Of course it's not realistic because again, you don't just miss the best 50 days, you end up missing a lot of the bad days. And if you miss a lot of the bad days, then guess what? The returns go up again. But I like these little charts, because I think they're fascinating. I think it's also a way in which data can confuse people rather than just clarify things. And I'm here to clarify it for you.

Okay, so where are we on, again, a bit more data market scenario. S&P 500 index curative price return during a recession. Now we're not technically in a recession yet. Worst case, minus 18%. That was in 2001. Base case, 16% return. That's the average. Best case you could be making over 44%. That's what happened in 2020 despite there being a recession. Historical data shows that on average, yes, it'd be 500 as returned 16% one year after the start of a recession. So you might be thinking, can we just get on with starting the recession now, because within the next year I'll get a 16% return. And you're right. That's what history suggests.

What about during Fed rate hike cycles? This caught my eye as well, because that's what we're in. What's the annualized return? Again, a bit of positive news. It tends to be positive. Virtually every single year when the Fed's hiking rates, it tends to be rather good news for the stock market. Well, isn't that good news?

Put another way, the S&P annualized total return, the S&P 500 had positive returns, 11 out of 12 times during periods of rising interest rates. 11 out of 12 times. So what I just showed you. That's great. And they're doing it now. So over that period that it's going to go through this cycle, we should be expecting a rebound of not just making up what we've lost so far, which is about 20% as I showed you earlier. We should be making that up, which means a 25% rise from where we are now, and then some, by the time they stop raising rates. And that will mean we've gone into a recession and we're one year away from it. That's what'll happen. That's when it'll happen.

This one from Bank of America caught my eye. Valuation is almost all that matters for long term stock returns. So they looked at valuation of companies. And they looked at what if you held them for 12 years? How important was valuation? Well, valuation was all that mattered once you start holding stocks for 10 to 12 years. The problem with that is we tend to hold things for a year. Most people wouldn't buy a stock and hold it for 10, 12 years. And if they did, well, it'd be a hell of a long time to wait to find out if that was one of those stocks, which this did hold true for or not. That's why we tend to hold for one year where, yes, I know valuation isn't very important, but we do take it into consideration, and we take in the other factors into consideration such as momentum growth and so on. And that's our approach. And I thought this was a good way of exhibiting it.

Let's just look at the US dollar. So the US dollar, so as you know, it's pound US dollar. And the pound has plummeted to one spot zero six at the time I took this image in actual, it's now at about one spot zero nine. Okay? Or one spot 10 to the dollar. So the dollar's incredibly strong. You're going to get a lot of Americans coming to Britain for Christmas. You're all welcome. Do come round, come to my place. But what does that mean? Well, I showed you one problem that meant already, which is diminishing chances of exceeding revenues by American companies. But I also think there's a historic buying opportunity. I actually think from where we are at the moment, which is here, and we've sort of been there before, couple of times before, we're probably going to be up, maybe not 21% in one and a half years, maybe the slope might be more like this, and it tends not to go in a straight line. It'll probably be like this and zig zag and all the rest of it, but I suspect there's a lot of money to be made. It's another way of saying, I'm buying sterling and selling US dollars.

Something else, which is going to happen, UK companies face new wave of takeovers. Well, this is by how much the largest 350 UK companies have fallen. I've taken the all those fallers in the 350 largest UK companies, which have dropped more than 49%, and there's quite a lot of them. But that's in pound terms. So take Aston Martin, that's fallen 76% in pound terms. In dollar terms, it's fallen probably closer to 90%. That makes it cheap. Makes all of these cheap for our American cousins to come in and start looking at buying some of these, maybe a Marks and Spencers. Okay, maybe a Carnival, the cruise liners for Expo. Oh, interesting. You are in iron, okay. Domino's Pizzas, pharmaceuticals, you've got a lot of things construction as well. So could that happen? May well happen. And I think it almost certainly will. I don't think it's going to happen in the next couple of weeks, because I think we're still waiting for the markets to steady a bit. But I bet you there's a lot of corporate finance houses and Goldman Sachs sort of rubbing their hands. Like I said with GVI newsletter. I'm going to give you this overall perspective, what's happening in the markets, but also I'll translate this as we go forward into which stocks we should be buying. This is to give you a bit of a background know-how on how we go about it. Thank you very much.