What does it take for us to typically see a bottom?
The American hedge fund Bridgewater recently published an interesting report on the current market situation. Here they analyze whether we’ve hit rock bottom or if there’s more torment in store for us (poor) investors.
For their analysis, Bridgewater looked at the last seven instances of inflation-driven bear markets dating back to the mid-1960s.
According to Bridgewater, we usually only see a bottom in stock prices during an inflationary period when two factors are present:
- There is a period of sufficiently accommodative monetary policy to offset the negative economic momentum
- Share prices fall sufficiently to investors are once again incentivized to take on more risk and start buying stocks.
What is Bridgewater's expectation?
The report shows that few of the typical characteristics of an inflation-driven bottom are present: the US economy remains relatively strong, unemployment is historically low and central banks continue to tighten monetary policy, including raising interest rates.
In addition, the declines we’ve seen in stock prices can largely be explained by higher interest rates. The interest rate is used to discount future cash flows back to the present, and when interest rates rise, an analyst’s valuation of a company will typically be lower when doing a DCF. However, if we look at analysts’ earnings (EPS) expectations, they have only changed marginally. If it turns out that the economy slows down and companies will earn less in the future, this parameter in the calculation of company value will also have to be adjusted negatively.
Based on this, Bridgewater concludes that we have hardly reached the real bottom, but should expect further declines in equity prices.
“Many of the key markers of an inflation-driven bear market bottom are still missing today- little real economic weakening, few signs the central bank is ready to move to easing, and, as of yet, not much repricing of equities beyond the direct drag from rising interest rates.
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– Erin Miles & Khia Kurtenbach, Bridgewater
