Broker Check

Valuations Look Attractive as the Markets have Discounted a lot of Bad News ...

June 06, 2022

"The stock market is a giant distraction from the business of investing" 

John C. Bogle

The stock market is stuck on the very negative narrative that the US is heading into stagflation: a recession with inflation.  This has driven valuations for the S&P 500’s next 12 month Price/Earnings ratio to its 10 year average very quickly. 

For investors, this is not a time to sell, just as it was not a time to sell in March 2020 when COVID 19 was detected in the US.

Inflation is the main reason that has caused stocks to go into a bear market (a drop from the peak of 20% or more).  Speculators that have shorted the market and want it to go down are saying the Federal Reserve will be forced to raise interest rates so high, that it will put the US economy into a deep recession, and is the only way to stop inflation.  This is what Federal Reserve Chairman, Paul Volcker, did in the 1979- 1980’s period. Volcker killed the economy to kill inflation and it was painful.  Inflation back then was driven by years of excess spending: Vietnam War, Great Society legislation/War on Poverty; strong unions and the OPEC oil embargo.  That period’s inflation took over 20 years to build up.  Inflation now is mainly due to the global pandemic: global supply chain problems combined with an explosive reopening of the economy from lockdowns.  The Russia/Ukraine conflict added to recent inflationary pressures, especially in energy and wheat.

Inflation (CPI) 

With stagflation being priced in, sentiment can change quickly as inflation data becomes less bad. 

As the US recovery from COVID shifts from the purchase of goods to services, inflation will come down.  The global supply chain could not respond to the spike in demand and prices shot up for used/new cars, furniture and appliances;  these prices are beginning to decline.  Now the rise in inflation is coming from the services side: airline fares and hotel room rates; but the rise is much less than that of goods. 

This rotation from goods to services is what Target’s earnings revealed: demand for TV, appliances and furniture dropped sharply while demand for luggage increased tremendously as people vacationed.  Target and every retailer now have excess inventory in TVs and this will be very deflationary.  I recently vacationed in Orlando and checked out the TV section for a massive Target and every TV was on sale.

The Russia/Ukraine conflict caused oil and wheat prices to explode and distracted from the improvement on inflation from the rotation from goods to services in the US.  Below are charts for oil and wheat: I do not see how they can make much higher upward moves from current levels.  They may stabilize and perhaps go lower as Saudi Arabia/OPEC+ have discussed raising oil production and Russia is talking about allowing Ukrainian wheat to be exported via the Black Sea, with Turkey coordinating efforts.  Something may be done here as the Arab nations are very worried about high wheat prices, which led to the Arab Spring uprisings.

Oil Prices


 Wheat Prices

Valuations have discounted a lot of bad news in a very short time.  With sentiment so low, less bad news or improving news can change sentiment just as quickly.

The situation has caused a lot of anxiety.  Please do not hesitate to reach out to you portfolio manager and/or relationship manager to discuss your concerns.