By and large, I’ve turned more bearish in recent months but it’s completely possible that I’m entirely wrong about my grim warnings. I’ve been scaling back my equities position marginally but if I’m honest I’ve not sold too much – it’s mainly just not investing fresh cash. I certainly haven’t started putting on log volatility positions, yet. Perhaps this is a classic case of cognitive dissonance. I would like to think I am more bearish but in reality, I’ve seen no hard evidence to justify scaling back risk?

One reason why I’ve maybe not gone full bear is that corporate earnings are still charging ahead.  According to BlackRock, the US corporates are still reporting impressive numbers.

“Companies representing more than half of the S&P 500 Index market value have reported third-quarter earnings. Over 80% of them have beaten expectations on profit and more than three quarters have exceeded revenue estimates. These beat rates are slightly below the elevated levels of the past few quarters but well above long-term averages. Multiples surged last year as investors eyed the strong rebound from the Covid-19 shutdowns – and earnings growth has delivered in the powerful economic restart. Multiples have since declined slightly, but that only reflects that markets had priced in this earnings strength and would be less responsive to the actual outcome compared with a typical business cycle recovery, in our view.”

Even European corporates are in decent shape. According to analysts at Morgan Stanley,

“3Q results tracked so far point to (1) an improved net beat rate with +36% of stocks beating EPS estimates; (2) a strong breadth of sales beats at +39%; (3) weighted earnings tracking 10% ahead of expectations”.

So far, very convincing but I can’t resist thinking that the current mood is a product of Central bank designed easy money swishing through system based on FOMO (fear of missing out). On that score, we shouldn’t be focused overly on corporate earnings but on liquidity drivers. On this score analysts at Cross Border Capital – who focus on liquidity measures – have turned notably bearish.

They reckon that both US private sector liquidity and US cross-border capital inflows have

“… already turned lower from exceptionally high levels, whereas US Fed liquidity remains unusually elevated. Yet, this latter extension is down to one-off factors, namely the addition of the latest IMF SDR allocation to Fed assets and the liquidity boost that derives from the US debt ceiling and the forced run-down in the Treasury General Account. For comparison, elsewhere, 41% of Central Banks in the Advanced Economies are now running ‘tight’ liquidity policies compared to zero in January. Our analysis confirms what we already know that the Fed and other Central Banks have recently been the dominant drivers of higher asset prices. This suggests that the upcoming Fed taper could prove risky for Wall Street. Time will tell, but history unambiguously shows that liquidity moves markets, with its presence vital for financial stability. But Global Liquidity is now falling…”.

The graphic below, also from Cross Border, offers one explanation about why we should care – many of the previous US Stockmarket corrections have been the product  of previous liquidity squeezes.

If we do have a correction then we can expect it to have long-lasting impacts. That at least is the message of the GMO Asset Allocation team who’ve developed the chart below which shows the four major U.S. equity bubbles dating back to 1929, illustrating just how long it really takes for investors to climb back to historical levels of return.

GMO observes that

“…each line measures the initial damage done when the bubble bursts, and then tracks how long it subsequently takes an investor to climb back to their “expected” 6% real return. It’s typically decades. Even with the amazing returns U.S. stocks have delivered for the past ten years, the S&P 500 Index has still not climbed out of the hole created by the tech bubble of 1999 (the red line, above). Bubbles inflict deep and cruel wounds, and it is right and prudent to avoid them, exploit them, or dance around them as best we can.”