Equities got a real spanking this week as market participants became concerned about a deterioration of the relationship between two critical value drivers: the state of the global economy and the cost of capital.1 The last such episode occurred in February.
Investors’ conviction in the robustness of the macroeconomic cycle has been shaken by decent but patchy Q3 results, including in Diversified Industrials. Earnings have unlikely peaked, but earnings growth might have. That said, in an attempt to interpret this week’s events, I would identify the increase in the cost of capital in US dollar and its implications for global finance as the primary cause for the sombre stock market performance.
A significant rise in the 10-year US government bond yield has occurred since the beginning of September, from 2.85% to a peak of 3.23% in early October and currently 3.08%. This new regime has simply not been associated with a positive revision of the long term growth outlook. The declining difference between growth and cost of capital has mechanically squeezed valuation multiples, with the Q3 results only acting as a catalyst for the adjustment.
The market is moving from ‘TINA’ or ‘there is no alternative’ to equities to earn a return on investment to ‘TIARA’ or ‘there is a real alternative’ to the stock market. Investors have been getting more choice in their search for returns for the first time since the Great Financial Crisis. A global investment portfolio rebalancing process at the expense of equities is due. Note that, notwithstanding the dramatic headlines, all technical indicators show that there was actually no panic this week.
‘Twenty-one pilots’ is one of the best music bands of the moment (Note: Wembley, 3/19). Watch and listen to ‘Migraine’ as an entry point. It may not lighten the mood but it will bring any listener far away from the mediocrity of top charts. In their recently released album ‘Trench’, they write a song about the cleansing effect of certain actions on the body and the mind, using the drinking of chlorine as an image:
Sippin’ on straight chlorine
Let the vibe slide over me
This beat is a chemical, beat is chemical
[…] The moment is medical
The stock market has been sipping on straight chlorine for a few days, with a cleansing effect on years of quantitative easing. The hope is that the dosage will be appropriate. Chlorine is poisonous. The moment is medical.
The world will be in a better place after a healthy resetting, especially with the impact of the self-inflicted tariffs issue on the US and China economies in the rear-view mirror. Furthermore, the acquisition of publicly-listed companies in Diversified Industrials may become easier to justify from a financial point of view, which would be welcomed: there remains so much to be done in the industry.