Financial Post: You Don't Need a Recession for Investors to Have a Tough Year

Article by David Rosenberg in Financial Post

Eighty percent of the stock market rally these past three years has been multiple expansion. Indeed, the expanded multiple in the 20 percent annualized surge in the S&P 500 was four-fifths multiple expansion to just one-fifth earnings growth.

Historically, it is normal for 70 percent of the move up in the market to be dictated by earnings (the fundamentals) and 30 percent to the expanded multiple (liquidity-induced animal spirits).

What did the past three years have in common that justified (for lack of a more appropriate term) the flip in that ratio? The United States Federal Reserve eased each and every year.

In 2019, it was 75 basis points of rate cuts. In 2020, it was 150 basis points of rate cuts alongside $3.2 trillion of balance-sheet expansion. In 2021, it was another $1.4 trillion of balance-sheet expansion. Only six other times in the past 90 years have we seen such a three-year stock market performance and through a pandemic to boot. Three years of Fed feast, but what happens to the market multiple when the famine starts?

After my CNBC Closing Bell interview on Friday afternoon, I saw my friend Jonathan Golub on the program, who was predictably optimistic. But his comment that “there’s no recession coming” is what caught my ear. The thing is, you don’t need a recession to have the market incur a rough year when liquidity conditions tighten up and P/E multiples mean revert.

We didn’t have recessions in 1987, 1994, 1998, 2002, 2007, 2014, 2016 and 2018 and all of them proved to be very challenging years for passive investors who were all in. Even the years that were saved by the Fed (1998, 2007 and 2018) were filled with heightened volatility — a major theme for this coming Year.

It is tough to find eras of inflation where financial assets perform very well, at least compared to real assets (real estate, precious metals, commodities). 

Rising inflation may well artificially boost sales revenues, but it also tends to camouflage what is really happening beneath the surface. This is why inflationary periods tend to see P/E multiples contract as opposed to expand, which is .......

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