10yy pricing in too much now? maybe so, says one stock-jockey; MARG
Good evening … In case you missed what was sent yesterday (a few sellside observations as well as a couple econ calendars with a bit of an inflation rant mixed in between), I thought I’d send this short note as this evenings markets open and the week gets underway.
We’re likely to hear more about MSs stock jockey in chief — Mike Wilson — and his latest rant in the days just ahead as he speaks to how / why,
… Our methodology is fairly simple, which doesn’t make it right but does make it easy to determine what kind of bet one is making. There are just two components – 10-year Treasury yields and the equity risk premium (ERP). At any given time, the P/E ratio and 10-year Treasury yields are observable from market prices. The equity risk premium is therefore just a plug based on those independent variables, making it relatively volatile. Year to date, the biggest driver of stocks has been the de-rating in valuations. To illustrate this point, the S&P 500 P/E has fallen approximately 20% while the price has fallen only 15%. At the lows just a few weeks ago, the P/E was down close to 24% when the index was down 20%. At that point, the P/E was 16x, right in line with our de-rating forecast for this year but above our current fair value multiple of 14.6x, which assumes an ERP of 370bp and a 10-year Treasury yield of 3.15% …
… At the end of last year, we had the opposite situation with the P/E at 21.5x (Exhibit 1). From our vantage point, both rates and ERP appeared to be mis-priced. Rates are obviously more levered to inflation expectations and Fed policy. At year-end, 10-year Treasuries did not properly reflect either risk. Today, we would argue that’s not the case. In fact, 10-year Treasuries may be pricing too much Fed tightening if growth continues to erode and recession risk becomes acute as Friday's consumer confidence number suggests…
ERP does not reflect rising risks to growth, in our view
Wait, what? Let THAT settle in as you do, check out yesterday’s note (and links to some other sellside rockstars) and as you attempt to plan your trades and trade your plans.
A couple other quick items which may / may NOT help you get your creative trade juice flowing …
Margin debt and the S&P via,
Interest rates are on the rise and investors are concerned.
Why?
One reason (of many) is that there is a significant amount of debt and the cost to carry that debt is increasing.
For some perspective, take today’s chart which overlays the 24-month change in inflation-adjusted margin debt on top of the inflation-adjusted S&P 500.
Conclusion…
The stock market has tended to struggle soon after a surge in margin debt.
Off to finish the weekend strong despite NYR exit last night … leaving fans behind like
… THAT is all for now.