By Alejandro A. Tagliavini *
Most analysts estimate that Wall Street is oversold in the short term, even so, the rallies on Thursday and Friday were to be expected given that it was coming from several negative days in a row. But upside potential remains limited, as Lance Roberts estimates, although we can still see a relative rally for the S&P 500 and the Nasdaq over the next week. But a more extensive correction is expected this summer as markets are in an exceptionally long stretch without an expected 5% correction, so the odds are increasing.
Corporate profits are increasing at a very rapid rate, and for these fairly high expectations to be met, economic growth should maintain a very high growth rate in 2022. However, interest rates – the yield – on bonds of the Treasury peaked a couple of months ago, suggesting that economic growth will weaken in the coming months. That is why analysts expect a 5-10% correction.
The University of Michigan’s monthly survey of consumer expectations consistently shows that shoppers are forecasting more “inflation” (rising CPI, strictly speaking). As can be seen in the following graph, there is a high correlation between economic growth and the rise in the CPI:
Given that the economy is made up of approximately 70% of consumption, strong peaks in “inflation” slow down purchases, thus lowering economic growth. This is particularly true when “inflation” affects the products consumed by the lowest 80% of the population, who consume the most.
Thus, investors are taking refuge in raw materials whose prices have been rising significantly, particularly in food and energy. Now, many analysts see deflation on the doorstep. Julien Bittel of Pictet Asset Management, warns that commodity prices are at high risk of a major reversal due to the sharp deceleration of the Chinese credit impulse, as can be seen in the following graph:
On the other hand, returning to the issue of equity markets, the correlation between Treasury bond rates and the economic composite – a compilation of the CPI, GDP growth and wages – suggests that current expectations of sustained economic expansion are too high optimistic. At the current rate, with bond yields in the 1.5-1.6% range, economic growth is likely to return very quickly to below 2% growth by 2022 as seen in the chart below.
Now, the recent surge in inflation pushed «earnings performance» into negative territory. The earnings yield has been the cornerstone of the ‘Fed Model’ which states that when the yield on equity earnings (earnings divided by price) is higher than the yield on Treasuries, it should be invested in shares and vice versa. The following table shows how the return on earnings is inverse – like the return on bonds – to the price of stocks.
Now, until recently, beyond the gains from the rise in the price of the stock itself, one of the main arguments in favor of stocks was that, although they did not perform much, at least they earned more than Treasuries, even after accounting for «inflation.» But with the rise in the CPI, the earnings performance of the S&P 500 has turned negative. When an investor in the S&P adds up his dividend check and his share of the profits, then subtracts the loss of purchasing power from inflation, he’s just matching. This is an all-time low, dating back to 1970.
For his part, Michael Kramer points out that the growth rate of the estimated S&P 500 earnings for 2022 has fallen considerably in recent weeks, from around 17% to approximately 12% today and could continue to fall. If that happens, we could expect the S&P 500 PER multiple to continue its downward trend as well.
Meanwhile, in Argentina, the Merval set a new all-time high in pesos, closing close to 60,000 points, remaining in dollars at 363 – in a situation where the dollar is relatively calm, with moderate rises – while shares abroad had important increases towards the end of last week, due to the redefinition of portfolios of external investors in view of the requalification by MSCI, an external climate favorable to emerging countries and positive expectations regarding the Paris Club.
Meanwhile, sovereign bonds performed poorly and analysts estimate that longer securities would be favored in relation to shorter ones given the negative scenario (restructuring).
In short, the monetary issue is still controlled and the reserves accumulated in May of the BCRA at a provisional level – the entity announces 48 hours late – of USD 1,624 M, surpassing the best mark of the Fernández-Pesce tandem thanks, precisely, to the increase international raw materials. With the May result, international reserves will close for the first time in the current government for six consecutive months of growth, although even so the balance since taking office remains negative at USD 1,898.
It is estimated that May purchases will exceed USD 2,000 M and that in the first five months of 2021 they will exceed USD 5,500 M. The issue is what will happen next when the heavy harvest ends and if the price of raw materials falls as we saw.
Thus, with a still relatively stable blue and against the lag in the interest rate of the traditional fixed deposits compared to inflation, in recent months there has been a strong growth of UVA fixed-term deposits.
Although some Common Investment Funds (FCI), such as the Money Market or the so-called T + 1, with very high liquidity, have also performed well. But they highlighted the funds that invest in assets (CER) adjustable for «inflation» – rise in the CPI, strictly speaking – since it soared. Particularly instruments that beat inflation by giving the CER plus a positive rate.
Although some recommend, for a horizon of several months, the so-called dollar linked funds that invest in instruments whose objective is to obtain a return that is close to the evolution of the official dollar, it is not so clear that the Government cannot continue to contain the official exchange rate tied, even after the legislative elections. Lastly, with what we saw of Wall Street and the dollar still in government control, the Cedears don’t look all that attractive.
*Senior Advisor, The Cedar Portfolio
Alejandro A. Tagliavini 
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