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Sign up now to receive our myFT Daily Digest email, delivering the latest news in the Equities market every morning. In the comments section of almost every markets article on this website, you’ll find someone expressing their opinion on how 13 years of zero-rate financial repression and loose monetary policy have contributed to an everything bubble of excessive risk-taking. Well, if you share these concerns, this chart is specifically for you:
[image: Morgan Stanley]
The ski-jump pattern of the blue line represents the expansion of the Fed’s balance sheet between March and May. During this period, it increased by nearly $400 billion to support uninsured bank deposits. While this wasn’t exactly quantitative easing (QE) – it involved lending to banks rather than purchasing their securities, so it didn’t directly create new money – it can still be seen as resembling QE. At the same time, the Treasury was depleting its general account and unable to issue supply due to debt-ceiling issues.
With the banking crisis averted, quantitative tightening (QT) is back. However, stocks have remained insulated, possibly due to the influence of AI or other factors. As a result, US equities appear expensive in both absolute and relative terms, with a forward earnings multiple of 20x compared to 14x for global equities, as reported by Berenberg. US stocks have only exceeded 20x twice before, during previous bubbles fueled by excess liquidity.
According to Andrew Sheets from Morgan Stanley, the entire global and US equity rallies have been driven by higher valuations, to an unusual extent. Over the past 25 years, there have only been two instances of more year-to-date multiple expansion – in 2009 and 2020. Both of these years were marked by deep recessions and substantial easing, supporting the argument that valuations should expand ahead of a longer-term rebound. However, this does not accurately describe the current situation in 2023.
It is also worth noting the unusual nature of the multiple expansion. Except for the big-tech seven, earnings expectations for other companies have been declining significantly:
[image: Barclays]
Now, the emerging problem seems to be disinflation, especially for companies that profited greatly during the latter stages of the pandemic. As inflation cools, pricing power will decrease, leading to potential sales disappointments and weaker operating margins as companies try to generate demand to clear inventory. Are we already witnessing the unwinding of greedflation? It is highly likely, as a fifth of US companies that have reported their second-quarter results have experienced downward revisions to earnings estimates. The sectors most affected by these cuts are consumer services, household & personal products, and capital goods.
So, what comes next? Will the yellow line go down, or will the Fed intervene and push the blue line up by implementing another put option? Or perhaps both? Maybe neither? It’s difficult to say for sure. However, if you have any insights or predictions, please share them in the comment box below.
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