Rudi’s View: Knock. Knock. Volatility Is Back!

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By Rudi Filapek-Vandyck, Editor

Ed Yardeni believes the S&P500 will reach 10,000 by 2030.

It seems like a bold prediction to make, typical, maybe, of the euphoric sentiment that surrounds share markets when indices are trading near all-time record highs.

More value-conscious investors have kept their eyes firmly focused on the elevated multiples and the narrow base from which equity indices have set new records this year, instead urging investors to remain vigilant and cautious.

Clearly, Yardeni is not that worried, instead predicting the absence of economic recession and the strong acceleration in growth ahead will take care of today’s bloated-looking valuations.

That prospective acceleration in growth, by the way, has less to do with the new US President, but more so with the latest technological break-through that is Artificial Intelligence (AI), which, through a variety of formats, promises to deliver efficiencies to industries and companies that are able to develop, integrate and employ this new technology to their own benefit.

Less regulation and tax cuts from Trump & Co are simply an added bonus, while drawbacks from tariffs and higher bond yields amp up general uncertainty.

Different, but the same?

Adding another 4000 points on top of today’s richly-valued US share market might prove less demanding than one might assume at first reflex.

Consider the long term average return of the S&P500 is around 10%, including dividends.

To achieve Yardeni’s trajectory for the coming five years would require a cumulative annual return of circa 10.75%, which is above the long-term average, but surely achievable with all the potential positives in waiting?

One added observation is today’s share market ‘valution’ is heavily skewed because of a small group of strong (out)performers. The large majority of share prices hasn’t moved in any significant fashion for up to three years.

If those share prices were to close the gap, the general starting point would be a much lower level in terms of valuations and base earnings.

The situation is not significantly different in Australia where the banks, unencumbered by the lack of earnings growth, have been responsible for a little less than half of total market gains from late last year’s starting point.

The other half stems predominantly from technology favourites such as Pro Medicus ((PME)), WiseTech Global ((WTC)), Hub24 ((HUB)), Netwealth Group ((NWL)), TechnologyOne ((TNE)) and Xero ((XRO)), plus data centre exposures and the occasional stand-out performer elsewhere.

For share markets to broaden their upward momentum, many are looking for today’s leaders to fail, with investors’ focus to return to cheaper priced laggards, but maybe that’s not where the answer lays for the next five years.

For share market bulls like Yardeni, the future remains with technology and AI. You either own the companies that provide and facilitate the technology or you own those companies that successfully use it.

The latter suggests any sustainable revival from old economy companies inside media, healthcare, telecom, retail, finance, et cetera might depend on each company’s ability to use AI to become more efficient, increase margins, accelerate and improve product development, grow sales and profits, and attract a higher valuation.

Tapping into that ‘the future is full of promise and potential’-enthusiasm, it is not difficult to see how the next five years could extend the current bull market until the end of the decade.

Three scenarios for the future

A recent strategy update by Dutch-based asset manager Robeco, now owned by Japan’s Orix Corp, suggests such a favourable outcome is by no means guaranteed.

Robeco’s investment strategy blueprint for the next five years does acknowledge there is potential for an AI-driven productivity boost, for sure, and if it does announce itself, it will dramatically transform the outlook for economies and financial markets.

But such an outcome is currently only given a 20% chance of happening.

A 30% chance is given to a bearish scenario in which excessive government spending and geopolitical turmoil lead to sluggish global growth and a noticeable pick-up in inflation, resulting in a deadfull stagflation scenario for the world at large.

If developments turn into the wrong direction, Robeco can see central banks being forced to opt for hard landings in order to keep a lid on re-invigorated inflation.

The most likely scenario, at 50% chance, is a bumpy road ahead, including elements of both scenarios mentioned, but with a net positive outcome overall.

In this scenario, the US economy remains the strongest among developed economies, but Europe and the UK will close part of the existing gap, Japan will see reflation and China will stabilise its housing market by 2026. India and various other emerging economies will continue experiencing robust economic growth.

Inflation will pick up yet again, which means limited rate cuts for central banks. By 2027 or so, the next round of rate hikes will become necessary.

Climate impacts will reverberate

Unsurprising, perhaps, as Robeco’s home base is in Rotterdam, the latest five-year prognosis also zooms in on climate changes and threats.

It is the forecasters assessment that weather events and changing climate have a slight negative impact on economic growth (on average) and a moderately positive influence on inflation.

That combination implies higher interest rates and bond yields for the years ahead, though not by default to the detriment of equities. The US dollar is expected to remain a strong currency.

As disruptive weather events will become more frequent, Robeco predicts financial markets will start paying attention and demanding a wider margin of safety, meaning equity valuations will be discounted to account for the added risk.

Investors are also expected to favour polluters that make genuine progress with reducing emissions and becoming a more sustainable business; i.e. pretenders will turn into cheaply valued laggards.

Contrary to the confidence expressed by Yardeni & Co, Robeco does have a problem with elevated valuation multiples for today’s share market winners in US equity markets.

The expectation is that in five years from today, lagging valuations and earnings in Europe and the UK will have narrowed the gap with expensive US markets, with emerging markets outperforming.

The team of Robeco strategists does acknowledge cheap valuations do not necessarily catch-up quickly and neither are more expensively priced assets -US equities- doomed to fail soon.

Their previous five-year outlook had also identified emerging marfket equities as the likely outperformer. That forecast has proved a big fail.

About bubbles that don’t burst

The Robeco report includes an interesting insight on historical asset bubbles with the report concluding less than half of all bubbles actually bursts and ends in tears for those invested in it.

The other ‘bubbles’ are standard not labelled as such as they don’t burst. Both variations share many of the same characteristics.

Robeco is not a fan of current US equity valuations, but the analysts are not prepared to predict today’s AI-driven ‘bubble’ will guaranteed burst. Detailed analysis and different methodologies all come to the same conclusion: US equities look ‘expensive’, but the set-up is not yet ‘excessive’.

If AI drives efficiency and increased profits in the years to come, it is well possible no burst is necessary to pull valuations back to earth. Future growth will take care of it then.

This scenario also implies the upward trend needs to be broadened; the current bull market cannot remain dependent on the same small group of expensive over-achievers.

The view Down Under

For investors in the Australian share market, whatever happens in the US remains key for trends and overall direction for ASX-listed investments, as also shown by the strong performance of local banks and technology stocks in the slipstream of their US peers.

Equally noteworthy: when healthcare stocks are out-of-favour on Wall Street, guess what is the likely direction of CSL ((CSL)) shares locally?

Potentially the most negative outcome for the local share market would be a bubble bursting and a devastating bear market next. Robeco’s research suggests a broadening of the uptrend might just be the antidote to keep that threat at bay.

Robeco’s three potential scenarios also suggest the jury remains out on whether Trump 2.0’s plans and policies will favour the positive over the negative.

After an initial enthusiastic response, financial markets are already zooming in on the potential threats of tariffs, higher bond yields, erratic nominations, and (potentially) an anti-vaxxer at the helm of the US healthcare department.

One of the key ingredients of Robeco’s most favoured scenario is more volatility, which will be a major change from the year past that saw very little interruptions to the strong underlying uptrend (at least at the index level). It’s the market’s response to higher uncertainties.

Judging from price action over the past two weeks, it looks like that environment of higher volatility has already begun.

Here’s how analysts at RBC Capital communicated with their clientele on Monday:

“We’ll cut to the chase – over the past week we’ve become increasingly convinced the S&P 500 may have already begun to experience another 5-10% drawdown or garden variety pullback”

The FNArena-Vested Equities All-Weather Model Portfolio had increased its cash allocation before the US election, and has not yet reinvested any of it in the local share market. There’s no hurry. Increased volatility will present opportunities.

All-Weather Model Portfolio

FY24 review for the All-Weather Model Portfolio:
https://www.fnarena.com/index.php/download-article/?n=DE2A4552-E2C7-4DC7-0A896CE5CF68ACD8

Prior years:

FY23: https://www.fnarena.com/index.php/download-article/?n=DFC11150-CB36-C777-1AA3EDA640E2F5BF

FY22: https://www.fnarena.com/index.php/download-article/?n=DFE7241B-9CD8-61F1-1602C581A8E539C4

FY21: https://www.fnarena.com/index.php/download-article/?n=DFF82691-E53E-3CF5-17A2337D72CDB54F

Video: Why FNArena & All-Weather Stocks

I’ve used my participation to the InvestmentMarkets’ conference in July to explain how/why FNArena started & what investors get out of it, including research in All-Weathers and Gen.Ai

The video: https://bit.ly/3A1pLuz

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

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(This story was written on Monday, 18th November, 2024. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).

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