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Against All Odds – Equities at Nosebleed Valuations in 2022

It appears that the Santa Claus rally did arrive and right on time spurred on by the continued hope that the Democrats could still save Biden’s Build Back Better $2+ trillion spending plan (more government stimulus) and the emerging view that the omicron variant of Covid produces milder symptoms and fewer hospitalizations/deaths than originally feared (and thus no/few government imposed economic restrictions).

Great! But Beware

As we have noted in prior blogs, while the major averages are at or still flirting with record highs, more than 40% of the components of the major indexes are in correction territory (down 10% or more from recent peaks).  Besides the extremely narrow equity leadership, all the traditional (historical) valuation metrics are at or near all-time highs and we have never had the extremities of leverage (margin borrowing) that are in today’s markets.  (“This time is different,” you say!  I refer you to Bob Farrell’s Rule No. 3: There are no new eras – excesses are never permanent.)  Clearly markets still believe in the Fed “Put,” i.e., the Fed will not tolerate a market collapse (expressed with the phrase “The Fed has your back”). 

Note that the Fed has taken the first steps and pre-announced an upcoming tightening cycle by initially disclosing a graduated end to its bond buying program (Quantitative Easing (QE)), then a speed up of that process, and further elaborating with some hints at where the decision making committee (FOMC) thinks rates will end up via a “dot-plot” (a much higher Federal Funds rate than its current level).  Some of the current Fed rhetoric may be political, as one of the Fed’s prime mandates is “price stability,” a problematic issue for the Biden Administration.  Still, tightening cycles usually end up causing significant disruptive economic consequences.

Against All Odds

History tells us that the odds of the Fed pulling off a “soft landing” (controlling inflation without causing a recession) are miniscule.  While it is true that the equity markets may still rise in the face of the first or even second Fed rate hike, a close look at those historical circumstances reveals that the economy was experiencing rapid growth – not today’s situation.  Because the Fed’s tools are blunt, designed to control the demand side, and act with an unknowably long and variable lag (a lag which appears to change as the economy evolves), tightening cycles almost always lead to recession.  (Hence, Scott Minerd’s (Guggenheim Partners) widely reported mid-December forecast of a 2023 recession!)

The Data

As noted above, equity markets can rise in the early stages of a Fed tightening if economic growth is strong.  And while Fed Chair Powell has extolled the strength of today’s domestic and worldwide economies in his most recent post-Fed meeting press conference, as we have chronicled in this blog, the data don’t back the “strong” economy narrative.   Here’s why:

  • The “shortage” narrative pulled holiday shopping forward.  Survey reports indicate that 60% of holiday shoppers shopped early.  October’s seasonally adjusted Retail Sales rose a strong +1.8% M/M, but November’s were a disappointing +0.3%.  “Super Saturday” sales were -19% lower than 2019’s.  This doesn’t portend well for December. 

  • Omicron has also had a negative impact.  At Thanksgiving, restaurant sales were about equal to those of 2019, but the latest post-omicron data show them now at a -12%.  In addition, the latest weekly data from TSA indicates passenger volumes are down -18% from the same 2019 week.  Note that none of this occurred due to government mandates; it was all consumer choice!  Given continued uncertainties, it is more likely that consumers will remain cautious than it is that they will open their wallets.

  • The global economy is weakening led by China’s imploding real estate sector and weakening retail (see “China Job Cuts Mount Under Curbs,” WSJ A-10 12/20/21).  The Chinese government has now locked down the city of Xi’an (13 million population) due to its zero tolerance Covid policy; this just weeks before the Beijing Olympics (620 miles to the north). 

  • The U.K. looks certain to fall back into recession and, in Europe German data have been softening.  Inventories of natural gas in the Eurozone are woefully low with natural gas prices fluctuating wildly based upon the latest long-term winter weather forecasts.  Once again, in the face of uncertainty, it is normal for consumers to retrench.

  • In the emerging market space, the rapid fall in commodity prices (due to the slowdown in China, the world’s biggest consumer of raw commodities) can only negatively impact as commodities are major exports for many of these economies.  We note that the Baltic Dry Index, which measures the cost of shipping bulk commodities, is down more than -60% from its nearby peak, a sign of flagging demand.

  • Within the U.S., we observe the following:

  • In the latest NY Fed Survey, the average full-time job offer fell to $56,036 (November) from $58,469 (July).  You wouldn’t know that from media reports.

  • The Chicago Fed National Activity Index (a comprehensive index of more than 80 variables) was .37 in November, less than half its .75 October level (the consensus forecast was .50, so a big miss).

  • The following two charts (both Not Seasonally Adjusted) show Continuing Unemployment Claims (CCs), those claiming benefits for more than one week, and Initial Unemployment Claims (ICs), a proxy for new layoffs.  CCs appear to have ratcheted up slightly as Q4 has progressed.   Similarly, ICs have also shown increases.  Note in the IC chart that layoffs are still well above their pre-pandemic norm.

Stock Buy-Backs

Back to the equity markets, in a recent article Lance Roberts (Real Investment Advice) had a chart that showed the huge impact that corporate stock buy-backs have had on S&P 500 returns since 2011 (see the chart at the top). 

It appears that corporate leaders believe that it is more efficient to use corporate cash to raise company stock values via buy-backs than it is to expand plant and equipment via new investment (capex).  All the Regional Fed surveys show capex intentions at extremely low levels, indicating corporate leaders’ downbeat view of future economic growth, a view that appears to have grown over the past decade.  As the Fed embarks upon a new tightening cycle, rising interest rates will only exacerbate that slowing capex trend.


In the new year:

  • The low level of capex plans reveals the underlying corporate managers’ view that economic growth will remain subdued for the foreseeable future.
  • Consumers appear to remain cautious in the face of ongoing uncertainties implying sluggish Retail Sales as 2022 begins.
  • The Fed will be less accommodative.
  • Residual inflation will continue to have a negative impact on consumer confidence.
  • The rest of the world appears to be slowing too.

Unlike Powell, we don’t see a “roaring” economy.  As we view the incoming data, we see a “slowing” one with the possibility of a recession if the Fed missteps.  And our view is not unique, as other well respected economists echo similar views.

As the new year approaches, we wonder what possible “narrative”, if there is one, could keep stock prices at “nosebleed” levels?

Robert Barone, Ph.D.

(Joshua Barone contributed to this article.)


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