Published On: February 16th, 2022|By |Categories: Market Updates|4.9 min read|

Last week we showed a long-term chart of U.S. real interest rates to make the point that the Fed is significantly behind in its belated decision to address persistently high inflation. The chart below which shows real interest rates in Europe since the formation of the euro reveals a similar message. European real rates are at their lowest level since the introduction of a unified monetary policy. Currently, the main difference between the U.S. and Europe is that the European authorities have not yet decided that it is necessary to fight the existing high inflation. Inflation in the U.S. has become a major political issue and recognized as a major threat to the economic expansion now underway. Europe remains complacent on the inflation front, still expecting it to recede in 2022 as supply side disruptions are solved and spare capacity is brough on-line.

Real Eurozone Deposit Rate

Source: Strategas Research Partners

This divergence in monetary policy is being reflected in the respective yield curves of both regions (chart below). The 2 year – 10 year spread in the U.S. continues to contract as short-term rates are rising more sharply than long rates as investors rachet up aggressively their expectation for Fed rate hikes this year. In Europe, long rates are rising more quickly as the consensus still expects no interest rate increase in Europe until well into 2023. The equity investing implication of this divergence are significant. From a regional perspective, Europe’s monetary policy remains more supportive of equities in general and could assist in Europe outgrowing the U.S. for the first time for many years. This would support the continuation of the month-to-date strong outperformance of Value stocks relative to the more expensive Growth stocks.

U.S. 2/10 Yield Curve vs. Germany 2/10 Yield Curve

Source: Ned Davis Research

The message from the bond market so far in 2022 is not one containing major growth scare concerns. The chart below shows that bonds are behaving differently in the current equity correction than in any other equity correction since quantitative easing commenced following the financial crisis of 2008-2009. This is the first +10% correction in which bond yields have risen and would suggest at this stage that the equity decline is more driven by a rotation out of over-valued stocks than by a concern over an imminent downturn in earnings

S&P 500 vs US 10-year Yield

Source: Ned Davis Research

This argument is further borne out in the chart below which shows the extent of the damage being inflicted on the more speculative segments of the market. The correction in the U.S. Nasdaq market is well underway with now 42% of its constituents having suffered a +50% decline from their 1-year highs. Investors are abandoning their erstwhile myopic concern with price momentum and now are recognizing the importance the market is starting to place on the fundamentals of sustainable earnings growth and reasonable valuations.

Nasdaq Composite vs. Percent of Stocks At Least 50% below 252-day High

Source: Ned Davis Research

Despite the substantial damage that has been inflicted at the stock level, the indices still appear resilient due to the high valuations assigned to the largest index constituents. Last week we included a graph showing the surge in valuation multiples assigned to the eight largest members of the U.S. index. This group still commands a greater than 8x sales to market cap ratio (all-time high) and sells at close to 40x earnings. In the past, when economic growth and hence, earnings growth, remained elusive, investors argued that these elevated multiples were deserved given the ability of these companies to grow faster than the market. However, a period of above-trend earnings growth combined with a general improvement in economic conditions has reduced the relative appeal of this elite group of stocks. The chart below shows that the expected 2022 earnings growth of the FAAMG stocks (Facebook, Apple, Amazon, Microsoft, Google) will lag that of the market. If rates continue to rise, the willingness of investors to continue to assign a valuation premium to this group will be crucial in determining the fate of the major index returns.

2022 Net Income Growth

Source: Strategas Research Partners

The first chart below shows the significant valuation premium currently assigned to Growth stocks even after their recent pullback. Should economic growth continue in 2022 as is expected, it would not be a stretch to expect that the normalization in valuation still has some way to go. The second table below just shows where the largest sector valuation increases have been since 2018 and thus highlights those areas of the European market most at risk from the ongoing correction in valuation multiples. It is not surprising that the largest technology segments of semiconductors and software reside at the top of those sectors most at risk. At the other end of the spectrum, sectors such as Materials, Energy and Financials sell for valuation multiples below what they did in 2018 despite currently experiencing much stronger earnings prospects.

Strong Disruption | Strong demand
Strong Disruption | Strong demand

Source: Strategas Research Partners

Turning our attention to shorter-term developments. The weakness in equity markets so far in 2022 has set up the conditions for a probable bounce in equity prices. The first chart below shows that the market has been temporary washed out (less than 35% of stocks have risen based on the average of the last 10 days). In addition, sentiment has become highly pessimistic on a number of indicators such as shown in the second chart where put/call volumes (sign of investors willingness for downside protection) have surged into the 99th percentil of historic observations.

S&P 500 NYSE Advancing Issues as % of Total - 10-Day Average

Bron: Bloomberg Finance

S&P 500 CBOE Put/Call Ratio 5-day Average

Source: Bloomberg Finance


Enter your email address below to receive macro updates directly in your inbox. Once a week, up to date forever. Unsubscribe whenever, wherever you want.


David Williams (1970) is responsible for the investment policy of Mpartners. After a brief career in diplomacy with the Ministry of Foreign affairs in Barbados, David joined Insinger de Beaufort asset management in 1997 and became a director in 2002. He was responsible for the investment team and the investment funds (long-only and hedged). His specialism is European equities. David holds a B.A. (Hons) from the University of Kent, an M.Sc. from the London School of Economics and an M.B.A. from Nijenrode university.