In The Two Weeks Since Start Of This “Global Shakeup” a Few Winners Are Emerging. PLUS: VIX -5.5% + S&P 500 Down 1%=Often Bottom

In the two weeks since the start of this “global shakeup” a few winners are emerging
The invasion and war between Russia-Ukraine is moving past its second week and financial markets have been roiled by the trifecta reinforcing risks of: (i) war risks; (ii) economic sanctions and associated soaring commodity prices and (iii) risk of escalation given Western fears of Putin. And for the most part, markets view this as solely a downside story. But that has not been entirely the case. With two weeks of conflict observed, here are three things we see as “gaining” or “stronger” compared to pre-Russia-Ukraine war:

• Commodity producers benefit from higher prices
• Energy supply and security is national security
• US equities have been massive outperformers, reflecting the USA role as “safe haven”

Take a look at the relative performance of regional stocks vs MSCI ACWI (all world index). Of the 7 indices below:

• USA and Latin America clearly outperforming
• Europe and EM have been massive underperformers

• Latin America outperformance is due mainly to commodity exposure
• Russia equities have imploded, yet the value of Russia commodity infrastructure has risen in value

This shows a more detailed breakout and this regional bias is clear:

• countries with greater exposure to USA outperform
• Canada and Latin America
• Both regions also are commodity producers

• Why is the USA leading?
• USA is arguably the most energy independent of the G10
• The Tech-focused energy industry is primarily USA
• USA is the safe haven

So, the obvious point is the US has become structurally more attractive and it is reflected in the positive relative performance. I would say this makes a lot of sense to me.

40% of the nations are commodity exporters, so this surge in prices is a positive for many nations
We first published this map from the CIA World Factbook in 2018, which shows how commodity dependent much of the world is and the significant recovery in commodity prices is creating the equivalent of a boom. As we know, this is asymmetric as those regions suffered a depression during the downturn and this lift more than offsets higher costs from consuming nations. This recovery in prices only took place in the past 6 months, which means it is not yet reflected in overall global GPD growth. Commodity producers, exporters and those countries leveraged to higher commodity prices are estimated to be 40% of global GDP growth. The countries marked with red arrows are positively levered to higher commodity prices.

• the point is many nations are benefitting from the surge in commodity prices
• Russia, ironically, is gaining given their huge beta to commodity prices

VIX fell 5.5% and S&P 500 down 1% =10 of 10 times, S&P 500 higher 12 months later = proximity to bottom
Steve Deppe @SJD10304 posted an interesting tweet yesterday and triggered some work by our data science team. Steve notes that something unusual happened yesterday:

• VIX was red (down)
• S&P 500 down -1% (at a point during market hours yesterday) – specifically, VIX down -5.5% and S&P 500 down 1%
• he said this could mark bottoms

…of 10 instances, avg 6M and 12M return is 16.8% and 3×5.2% = “can’t get hurt buying stocks here”
The results are displayed below. Tireless Ken found 10 instances of this dual combination:

• 10 of 10 times the S&P 500 higher 12 months later
• 8 of 10 times the S&P 500 higher 6 months later
• average gain 35.2% and 16.8%, respectively

In other words, stocks rallied hard eventually. This is consistent with our view that “one can’t get hurt buying stocks here” even if there remains downside risk.

…Every single instance was “proximity to low” and 8 of 10 at the lows…
Tireless Ken also plotted these instances below on a time series. It is apparent the emergence of these instances is at a market low. And 8 of 10 times it was the low

• hence, this is another reason
• to believe stocks “won’t hurt you in 12 months”

VALUATION: Equity valuations vs bonds the cheapest since Summer 2020 = “not demanding”
Equity valuations have come in sharply and this is a positive development. After all, many bears and critics over the past 18 months have cited valuations as a reason to be bearish. Take a look at a common valuation measurement, the “earnings yield” of S&P 500 compared to the 10-year bond:

• the EY less BY is 2.82%
• owning a stock gives an investor an earnings yield of 4.8%
• owning a bond is a yield of 2.0%

This is the most attractive valuation that we have seen in the last 18 months. This is evident looking at the chart below.

In fact, compared to the last 40 years, this is a very attractive valuation. The average valuation differential since 1980 is 0.30%.

• average differential is 0.30%
• the higher the value, the more attractive equities
• 2.82% is the upper end of the last 40 years

So, stocks have valuation support.

VALUATION: Equity valuations are just not demanding. Median P/E 16.7X now vs 18.6X in 2019
There has been tremendous P/E multiple compression since the start of 2022:

• Median P/E start of 2022 18.1X
• Median P/E now 16.7X

• Median P/E end of 2019 18.6X

The S&P 500 trades at 2X less than the multiple at the end of 2019.

• this is true even with
• higher profit margins
• lower interest rates
• better pricing power

So, valuation is not the issue for equities.

VALUATION: Median FCF yield now 5.5% versus 4.7% in 2019
The same is true for free cash flow yield. Below is the median FCF yield of the S&P 500:

• FCF yield start of 2022 5.0%
• FCF yield now 5.5%

• FCF yield at end of 2019 4.7%

In other words, the S&P 500 is far cheaper now than it was two years ago. And has fallen sharply even since the start of the year. If there is no recession, which is our base case, then stocks are very attractively valued currently.

OIL BURDEN FAR LOWER: $130 is 3% of consumer wallet, still below 4.5% in 2008 and 6.5% in 1980

• yesterday, oil at $130, gasoline is 3% of wallet
• this is 33% less than 2008 impact
• because the economy is larger and energy intensity is down

• even $200 oil is 4% of wallet
• this is less than 4.5% of 2008 and 6.5% of 1980

So, while the increase in gasoline prices is a shock, and certainly the “rate of change” is as well. This is a far lower hit to consumers compared to 2008. That said, this is still going to be painful for those who have smaller wallets, or drive gas guzzlers.

But of course, these are merely theoretical explanations. Consumers can panic and lose confidence over many factors. And the war and the threat of further surges could certainly drive this reaction.

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