Market Euphoria is Based on Three Dangerous Myths

Market Euphoria is Based on Three Dangerous Myths

Market Euphoria is Based on Three Dangerous Myths

World equity markets concluded November with their most substantial monthly rally in three years.

Optimism comes from better-than-expected inflation figures, expectations of central bank rate cuts, and general acceptance that earnings and economic growth will be weak but acceptable in 2024.

The main challenge for investors in 2024 is to confirm these hopes as trends.

The first problem is believing that inflation will drop magically without any significant impact on growth and ignoring monetary aggregates.

Inflation is falling due to the significant decline in money growth, and this means an abrupt slump in liquidity, a weaker economy, and financial conditions worsening.

Broad money (M3) growth is down 0.9% in the United States in the year to September, according to data compiled by the Institute of International Monetary Research. In the euro area, broad money growth was -1.0%, according to the ECB.

The United States will need to refinance $7 trillion of maturities in a declining broad money economy, and this means a massive vacuum effect. a giant liquidity drain that hardly justifies multiple expansions and bullish sentiment.

Market participants cannot expect the Federal Reserve to implement massive rate cuts and even a quantitative easing program in the middle of an election year. Furthermore, even if the Fed cuts rates, the impact is likely to be negligible compared to a seven- to ten-trillion-dollar liquidity drain, which is the equivalent of the refinancing required by the U.S. and other major governments in 2024.

Trusting in multiple expansions is concerning because, in order to achieve that, markets would need to count on rising liquidity, not a reduction.

The S&P 500 trades at a price-to-earnings ratio of 18.8 times if you believe the more than cheerful expectation of adjusted earnings growth for 2024 of 13.42% and a dividend yield of 1.61%. This implies an enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) of 14.18 times, 2.4 x Price to Book, driven by Tech Megacaps. Europe looks cheap, but Europe always seems cheap for a reason. However, that is due to the difference in composition. The European stock market lacks the technology giants’ weight of the United States’, and its largest components are mature, low-growth stocks. Still at 12.8x Price to Earnings, 1.85 times Price to Book seems like a steep valuation to accept for utilities, banks, and mature industries, many of which have a poor track record of value destruction. Most stock markets are not cheap and need positive earnings’ surprise as well as rising liquidity to continue the bullish trend. None of those are likely.

In a scenario of liquidity drain, investors need to go back to fundamentals and pick the stocks that will keep margins and growth in a weak economy, but not bet on multiple expansion.

Market optimism is based on the idea that the unprecedented liquidity drains and declines in monetary aggregates will have no impact on earnings, margins, access to capital, or economic growth.

The only bullish argument that is often repeated is that central banks will act quickly if markets and economic figures deteriorate. That may be the case, but not as quickly as market participants may desire and certainly not in the size required to offset the monetary aggregate slump.

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Daniel Lacalle

Global Economy Expert

Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of EconomicsFunds Society Forum in Miami, World Economic ForumForecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBCWorld Economic ForumEpoch TimesMises InstituteHedgeyeZero HedgeFocus Economics, Seeking Alpha, El EspañolThe Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).

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