Hedley Market Commentary - September 2021

With many global equity markets near all-time highs, there are a number of financial commentators and investors worried that the peak is in sight with valuations looking stretched on most historical measures and company profit margins also at high levels.

While interest rates remain low throughout the world then higher than average valuation levels can certainly be justified. However, with economies reopening, supply chain issues are causing prices to rise and labour costs to move ahead, leading to higher inflation and, with it, the threat of higher interest rates to curb the momentum. Central bankers across the world are reassuring investors that this inflation is transitory and will fade and for now, this has soothed the nerves; but the reality is that no one really knows how this will play out.

In addition to the prospect of higher interest rates, the US Federal Reserve has been readying markets for their bond purchase programme to be reduced. While any tapering is likely to occur at a very slow and measured pace, it should be remembered that the Fed presently holds around $8.5 trn US debt out of a total $28.5 trn, so it is an important and large buyer of debt issuance, which will therefore, be less supportive in the future.

US government bonds presently yield around 1.3% for 10 years, which sits uncomfortably with inflation levels of 5% and for the moment, financial markets remain sanguine over this mismatch. While this lasts, then governments will be happy at funding their obligations at a rate well below inflation while at the same time, taking advantage of inflating away current debt.

However, while there is certainly much to be concerned about, primarily because we have never witnessed an economic environment quite like this (and this is without the further uncertainty of Covid recovery), it is also worth looking at the wider equity picture. Much of the extraordinary economic momentum has occurred in the US, with the Trump administration fuelling the domestic economy with a borrowing spree like we have never before witnessed. US equity valuations have also widened from around 17x PER just 5 years ago, to over 22x presently. Some of this, it can be argued, it because the US has higher growth stocks and therefore, deserves this rating. The UK, on the other hand, has many more mature companies, but, nonetheless, was on PER of 17x 5 years ago, and today it is around 13.5x.

Whatever lies ahead over coming quarters, there is no doubt that there will be volatility along the way as there is simply too much uncertainty over economic outcomes and as support is slowly withdrawn by governments, then this uncertainty will increase. In addition, stock valuations in some areas seem perfectly priced, which could exacerbate the volatility. However, central bankers should not be seen as trying to wreak havoc, they are merely trying to wean us all off cheap money as delicately as possible and will do whatever it takes to not rush this process and to take markets along with them.

This market commentary is not intended to provide information sufficient to make an investment decision.

All opinions contained in this report constitute Hedley & Company Stockbrokers Limited's judgment as atthe date of this report, and are subject to change without notice and are provided in good faith but without legal responsibility.

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