For the first time since the 1970s the sense of fiat currency erosion relative to financial assets and consumer prices due to misguided policies has penetrated the mindset of investors in a significant way.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
Nonetheless, easy and cheap access to capital has also been one of the key reasons for the historical disconnection between asset prices and fundamentals.
In fact, the sheer amount of financial assets today that trade at near record multiples is truly concerning.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
Preventing a collapse in risky assets has become a true policy constraint for monetary authorities.
Different than other times in history, the Fed’s ability to allow the cost capital to substantially rise is incredibly limited.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
To use the US stock market as an example:
The 5-year cyclically adjusted earnings yield is now near all-time lows.
In other words, investors are undeservedly paying excessive prices relative to bottom-line fundamentals.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
For every one of these periods, the market unexpectedly reversed from very bullish multi-year trends with an average subsequent 3-year performance of -53%.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
Naturally, as different opportunities present themselves over time, market positioning and capital allocation tend to change drastically every five years or so causing major reversal trends.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
Now let’s address the elephant in room.
You would think that a low interest rate environment would be positive for stocks, but that is far from the truth.
The problem is that inflation is running much higher than interest rates.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
When we look at valuations of equities versus 10-year real yields in the last 120 years, equity fundamental multiples significantly compressed when real yields were negative for a long period of time.
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
To be fair, however, this is the first time we have seen negative 10-year real rates with valuations at historic levels.
Also, to recall:
Commodities performed exceptionally well during the three highlighted times. pic.twitter.com/yO5lO2SlOA
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021
Since the GFC, the increase in government debt has been directly linked to the increase in net worth of the US population.
One important difference from prior years, however, is that fiscal policies are increasingly becoming more focused on the bottom 50%. pic.twitter.com/BOMhrOHkQy
— Otavio (Tavi) Costa (@TaviCosta) August 31, 2021