It’s been very painful and I think it’s clear that not only are equity markets nervous and edgy, but they’re hyper, hyper sensitive to inflationary data. Whether it’s FOMC meeting or even today’s payroll numbers, it’s really about getting some comfort that inflation is breaking.
From our perspective, it’s been painful. And I don’t want to sound like I’m trying to be stubborn, but I think the risk-reward for equities here has improved this week. I know it sounds glib to say, Well, everything’s 5% lower, that’s why you like it, but No. 1, on the FAANG trade, I just think that multiples are still becoming gifts, especially if we have a soft landing or even a mild recession.
How do we apply this to 2022? Please counter-trade consensus panic — whatever the panic is
Before telling us that this means the Fed is the only thing that matters, that is not how I see it. The takeaway is:
- consensus panics about something
- says there is no way out
- except for markets to crash
- counter-trade this
The future is uncertain, so take this as simply another perspective
Equities have rallied post-FOMC 5 of the last 6 meetings
Stocks initially rallied after Fed day only to fall sharply Thursday. Below, we have highlighted equity performance post-FOMC in the last 6 meetings:
- 5 of last 6 meetings, equities have staged rallies of 3% to 9%
- Sept 2021 was the exception and stocks fell.
Given the huge decline in stocks into this May FOMC, we think odds favor an outcome similar to the 5 rallies = stocks could bounce in May. We have a lot of egg on our face, so we say this, knowing markets have been marching to a new tune.
STRATEGY: From 1990 to 2008, 10-year yield averaged 5.3% and S&P 500 P/E 18X vs 18X today
We think stocks remain the best risk/reward for the next 5 years (Bitcoin as well). And this is especially true if interest rates drift higher — bonds will lose money. This idea of TINA remains important as one thinks of asset allocation.
Now we realize many clients say the S&P 500 P/E needs to de-rate, or fall, if 10-year risk-free rate rises.
- S&P 500 P/E is 18X
- 10-year is 2.9%
- Many investors believe if 10-year rises further, P/E needs to fall
This, however, is not really supported by market history. Take a look below:
- from 1990 to 2010, or 20-years, the 20-year averaged 5.3%
- S&P 500 P/E averaged 17.7X
- 10-year is 2.9% today vs 5.3% (from 1990 to 2010)
- S&P 500 P/E is 18X vs 17.7X (from 1990 to 2010)
So, there is a whole lot of room for yields to rise. But arguably:
- the S&P 500 P/E is already at levels associated with a 5.3% 10-year
- in other words, a lot of bad news is priced in
…If FAANG stabilizes, market overall has footing
We realize technicals have been terrible. And many are also negative because FAANG has been falling since November 2021, meaning FAANG has been leading the market lower. We think FAANG might have finally fallen enough to become attractive risk/reward:
- FCF yield 6%-plus of FB GOOG 0.88%
- Cash as % market cap 6% to 9% for NFLX 1.11% FB GOOG 0.88%
- Even P/E 12X and 16X for FB GOOG 0.88%
So, valuations are close to “value” and these companies can generate top-line growth above that of GDP and with superior ROIC and ROE. In fact, these are cash-rich companies.
…6 of 7 big FAANG stocks have outperformed last 5 days
Another encouraging sign is that 6 of the 7 major FAANG stocks have outperformed last 5 days:
- only laggard is AMZN 3.74%
- best is FB, outperforming by ~2,000bp past 5 days
If FAANG has found its footing, we think stocks overall can bottom ahead of technicals
Recall, Market has flipped and now faster growing companies trade at a discount to slow growers… Growth is now Value?
I want to highlight this again. Look at how growth rates and valuation have completely inverted:
- Faster revs growth = lower valuations vs slow growers
- Faster revs growth = higher FCF yields vs slow growers
- the coefficients have completely flipped, as shown below
- Why would the market price faster top-line at a lower valuation?
This is sort of the opposite of common sense. Companies with faster growth (Growth stocks) are trading at a discount to slower growers. This is true for either P/E or free cash flow. I am not sure this makes a lot of sense.
Figure: Themes in 2022 – “BEEF”
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
* Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”
