Earnings risk is being contemplated by markets
QVG Capital Management
Inflation driving higher rates and earnings risk (given recession fears), combined with tax-loss selling and flows out of equities, to deliver a horror month for the Small Ords. The benchmark fell -13.1% for June delivered the second worst monthly return since the GFC.
The Aussie 10-year bond rate started the month at 3.34% and finished it at 3.66% but not before touching a high of 4.25% intra-month. The US 10-year Treasury Bond interest rate showed a similar pattern, starting the month with a 2.83% yield and finishing it at 3.06% via a 3.48% high. The moves lower in global and domestic equities are starting to price these higher rates.
The new fear gripping markets is earnings risk. Depending on who you read, the average US recession sees -13% to -17% earnings cuts (the GFC was a lot worse). It is this earnings risk that is now being contemplated by markets. We have managed money in rising and falling rate environments and know which we prefer! In the past, rising rate environments have been gradual enough so that the earnings growth of our portfolio has compensated for multiple compression from higher rates.
The unique feature of this market is not the magnitude but the speed of the move in rates which has led to the fastest compression of valuations ever as shown here:
Valuations have never before compressed so quickly
Year-on-year change in trailing Price/Earnings multiple of the S&P 500
The chart above shows we have been sailing into the wind, but it won't always be this way. Given the next leg of this bear market is likely to be a focus on earnings not multiples, we have been positioning the portfolio towards companies we believe have greater earnings certainty. This ought to mitigate the impact on the portfolio of a recessionary or slowing growth environment should it occur.
Funds operated by this manager: