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January 24, 2023

Confidence buoyed by conviction that inflation has peaked - despite Fed skepticism

Markets are convinced that inflation has already peaked and that interest rates should follow suit by Q2 this year.

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The Fed remains more skeptical and awaits evidence of services inflation turning a corner.

Asset performance since mid-October reflects growing confidence about the inflation outlook.

Chart 1 shows the returns accrued by the FT Wilshire 5000, US bonds and the US dollar from the low point reached on October 14th last year and performance YTD for 2023. While both equities and bonds have rallied strongly the dollar has fallen sharply. The common denominator between these divergent moves is growing conviction that US inflation has already peaked and that US interest rates will follow suit.

Chart 1: Move in US assets since October 14th low and YTD

Source: Wilshire, Refinitiv, FactSet. Data as of January 17, 2023

Key inflation gauges seem to have peaked several months ago

Chart 2 plots the key US inflation indicators and shows a profile of inflation peaking (and subsequently declining) over the last six months. In fact the Fed's key indicator the Core PCE deflator peaked in February 2022. It also appears that the Fed ramped up its hawkishness as evidence of the peak started to appear.

Chart 2: Key US inflation gauges appear to have peaked several months ago

Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023

However, the Fed is probably waiting for evidence of services inflation to peak

Chart 3 shows that the key driver behind the peak in inflation has been the rapidity of the decline in both goods inflation and input prices as measured by the PPI indicator. Services inflation has yet to peak, and the Fed will probably need to see this confirmed in subsequent data to change tack on interest rates.


Chart 3: Declining goods inflation but services inflation (the Fed's focus) remains elevated.

Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023

A gap between market and the Fed's interest rate curve forecasts - fade vs higher for longer

Chart 4 plots both the markets interest rate and Federal reserve dot plot curve forecasts. The market expects rates to peak close to 5% in Q2 but then to 'fade' lower into the second half of the year as growth headwinds and disinflationary pressures push rates lower. However, Fed forecasts paint a picture of continued increases throughout the course of the year reaching peak rate by the end of the year (higher for longer).

Chart 4: Mind the gap between the market and Fed interest rate forecasts

Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023

The Fed has started to 'taper' its hawkishness - impacting the dollar

While the Fed is still waiting for more evidence of inflation peaking it has been concerned that the deliver of restrictive financial conditions runs the risk of slowing the economy too aggressively and has subsequently started to rein in (taper) the scale of interest rate increases it is delivering at the FOMC meetings (see Chart 5). Tapering has been a contributory factor behind the weakening of the dollar.

Chart 5: The Fed is tapering the magnitude of rate hikes - impacting the dollar

Source: Wilshire, Refinitiv and Federal Reserve. Data as of January 17, 2023

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November 21, 2022

Moving to the phase where bad news becomes good news

The likelihood of the delivery of sustained disinflation in 2023

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Despite persistent fears that financial conditions are sufficiently restrictive to cause a slowdown next year, the positive market reaction to the weaker than expected October CPI data seemed to indicate a transition to a new phase of inflation dynamic analysis - the likelihood of the delivery of sustained disinflation in 2023.

Bad economic news feeds this narrative and therefore could now be seen as good news.

Chart 1: On the cusp of phase 3 of inflation analysis

 Source: Wilshire, Refinitiv. Data as of November 15, 2022

Intensified focus on the Fed’s disinflation forecast for 2023

Chart 1 plots the progression of the Fed’s core PCE inflation indicator. The twelve month period between February 2021 and February 2022 saw the inflation rate almost triple, generating the hawkish tilt by the Fed. Since then, the inflation rate has plateaued (albeit at an elevated level).

The focus now turns to the plausibility of inflation moving sequentially lower next year as predicted by the Fed. Their current forecast of year-end 2023 inflation reaching 3.1% requires a monthly run rate of 0.3%. A run rate of 0.2% a month would deliver a 2.4%-year end inflation level.

Forward looking indicators such as the ISM prices paid index point to continued downward pressure on headline inflation in the coming months.

Chart2:  The ISM manufacturing prices paid index points to lower US CPI  

 Source: Wilshire, Refinitiv. Data as of November 15, 2022



Perception that inflation could be peaking and then encountering disinflationary headwinds (after the October CPI report) produced a downward shift in the US interest rate curve as can be seen in Chart 3.

Any further signs of weakness in final demand (bad news) could now be the catalyst for continued downward shifts in the interest rate curve (good news).


Chart 3: US market rate expectations fell after the lower-than-expected US CPI numbers



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November 21, 2022

Unpacking the drivers behind the deteriorating US EPS growth trajectory

The second half of 2023 has seen the 2023 EPS growth rate forecast start to decline

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As can be seen in Chart 1, the second half of 2023 has seen the 2023 EPS growth rate forecast start to decline. This has clearly been connected to the rapidity of the commensurate decline in forward looking GDP growth forecasts.

Chart 1: 2023 EPS growth forecasts have followed GDP forecasts lower

Source: Wilshire and FactSet. Data as of November 15, 2022

Technology and Health Sectors have been the key drivers behind the downgrading

Chart 2 shows the sector weighted contribution to the aggregate 2023 market EPS growth rate. In May the forecast was for 12% EPS growth, and this has now declined to 7.9%. The main contributors to this 4.1% decline were the negative contributions from the tech and health sectors.

Chart 2: Comparing the US vs World ex US PE ratio moves over the last 20 years

Source: Wilshire and FactSet. Data as of November 15, 2022

There is a lot of seasonality built into the 2023 EPS projections

Chart 3 shows the progression of quarterly US EPS forecasts out to the end of 2023, with the blue bars showing the Q/Q growth rates and the grey line showing the quarterly forecast EPS (USD). As the chart shows, there is high levels of seasonality forecast over the next 12 months or so.

After flat or negative EPS growth expected for the next three quarters, a lot appears to be hinging on a recovery in EPS in Q3 and Q4 of next year.


Chart 3: A lot is riding on the delivery of a positive EPS inflection in Q3 2023

Source: Wilshire and FactSet. Data as of November 15, 2022

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November 2, 2022

October saw US equities rally on speculation the Fed might change tack

The FT Wilshire 5000 rallies 8.2% in October

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Having fallen sharply over the prior four-week period the FT Wilshire 5000 started to inflect sharply higher from mid-October closing out the month with a +8.2% return. There were two principal catalysts behind the recovery in risk appetite. The first was the market registered as significantly oversold in mid -October, reaching levels that typically see a subsequent rebound. The second catalyst was speculation that the Federal Reserve was becoming increasingly concerned about tightening too aggressively given mounting recession headwinds.

Exhibit 1: A robust recovery in the latter half of October

Source: Wilshire. Data as of October 31, 2022.

October saw a continued preference for Value vs Growth style


A key attribute of the recovery in risk appetite was the notable preference for Value over Growth as measured by the FT Wilshire 5000 style indexes. In October the Large Cap Value style index delivered a return of 11.6% while the Large Cap Growth style index only appreciated 4.2%. This rotation has been a dominant theme through the course of 2022 with Value outperforming Growth by 21.3% year to date.

Exhibit 2: A continuation of the sustained preference of Value vs Growth in 2022

Source: Wilshire. Data as of October 31, 2022

Financials and Energy sectors delivered the largest performance contributions

Dissecting market returns using sector weighted contributions ( the combined impact of sector performance and sector weighting) October saw the largest positive contribution from Financials followed by energy. Real estate and transportation sectors delivered the lowest contributions.

Exhibit 3: October performance driven by Financials and Energy

Source: Wilshire. Data as of October 31, 2022


The Year-to-Date drawdown of-24.9% is the sixth largest in 40 years

The YTD drawdown of-24.9% as of 30th is now the sixth largest witnessed over the last 40 years as shown in Exhibit 3.

Exhibit 4: Putting the YTD drawdown into perspective

 Source: Wilshire and Refinitiv. Data as of October 31, 2022


November 2, 2022

Differentiating bear market rallies vs meaningful inflection points

Bear markets are not linear – they typically witness numerous rallies

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From January 3rd to the recent low on October 14, the the FT Wilshire 5000 had registered a drawdown of -25.9% the sixth largest since 1980. The key observation about bear markets is that they are not linear – in fact they often move in a sawtooth manner marked by numerous bear market rallies. This has been observable in the trajectory of the FT Wilshire 5000 returns this year (see chart below). Bear market rallies reward the ‘sell the bounce’ discipline, the antithesis of ‘buy the dip’.

Exhibit 1: Bear markets typically see numerous tradeable rallies

Source: Wilshire and Refinitiv. Data as of October 31, 2022

Just under half the days in a bear market register positive returns

To reiterate the point that bear markets are not linear we have measured the trading pattern of bear markets (lasting more than three months) registered by the FT Wilshire 5000 since 1980. This shows that around 45% of the trading days witness upward moves. The bear market is driven by the compounding effect of the average daily move in a down day being -1.4% vs the average daily move on an up day being +1%.

Exhibit 2: The trading pattern of bear markets

Source: Wilshire and Refinitiv. Data as of October 31, 2022

How to differentiate a bear market rally from a sustained inflection point?

If bear markets witness numerous bear market rallies, how can we identify when a rally is marking a nadir followed by a sustained positive move?

One answer to this is to wait for key technical signal confirmation. The ‘Golden Cross’ (the positive intersect of the 50-day moving average with the 200-day moving average where the latter has bottomed) is a useful tool aiding the identification of major market inflection points.

Exhibit 3: The ‘Golden Cross’ helps identify key inflection points

Source: Wilshire and Refinitiv. Data as of October 31, 2022

October 21, 2022

The scale of the de-rating has pushed PEs back to Covid lows

Scale of the drawdown in global equities in 2022 has produced a significant de-rating with US equites experiencing one of the largest PE contractions

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The US has experienced one of the largest PE de-ratings in 2022

Chart 1 shows the status of regional 12m forward PEs, where these sat at the end of last year and the scale of the de-rating experienced so far in 2022. The UK and US have seen valuations decline by around a third, China and Europe ex UK by a quarter.

Chart 1: The scale of PE de-rating experienced across the regions in 2022

Source: Wilshire and FactSet. Data as of October 16, 2022

Putting the valuation shift into a longer perspective

Taking a longer-term view of valuations, Chart 2 shows the 12m forward PE for the US and World ex US over the past 20 years. The chart shows the sheer scale of the de-rating over the past 2 years. From its peak in September 2020 the US 12m forward PE has declined 36%, with World ex US also declining by the same quantum from its peak in July 2020. Although valuations are not far from the Covid sell-off lows, they are someway from the lows of the GFC, where the US and World ex US 12m forward Pes fell to 8.7x and 7.1x, respectively

Chart 2: Comparing the US v World ex US PE ratio moves over the last 20 years

Source: Wilshire and FactSet. Data as of October 17, 2022

The US 'fed model' (equity vs bond) valuation analysis

Chart 3 shows the Fed Model valuation (equity earnings yield minus 10-year government bond yield) since 1992 and looks at the average levels over 3 distinct periods. As we can see, although the current Fed Model valuation is below its post-GFC average, it is above the pre-GFC 2002-2008 average, and well above the negative levels experienced in the 1990s. From a Fed Model valuation standpoint, the rise in bond yields this year has partially offset the impact of the US equity market de-rating.

Chart 3: The US 'fed model' valuation looks stretched versus the last 10-year range but not versus the pre GFC period

Source: Wilshire, Refinitiv and FactSet. Data as of October 17, 2022

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October 21, 2022

Perspectives on the bear market – how long will sentiment languish at historic lows?

The FT Wilshire 5000 has experienced a technical bear market in 2022 (defined as at least a -20% drawdown)

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We examine the scale of the drawdown in the context of the 50-year history of the index and also look at return characteristics after reaching sentiment indicators lows.

Putting the 2022drawdown into 50-year context

Putting the 2022 drawdown into a historical context, Chart 1 shows FT Wilshire 5000 bear markets since the inception of the index in 1970, looking at the peak to trough move, as well the duration. As we can see the 2022’s bear market (so far) ranks as the seventh largest in history, and the fifth longest.

Chart 1: So far 2022 ranks as the fifth longest bear market in the FT Wilshire 5000’s history

Source: Wilshire. Data as of October 16, 2022

Sentiment indicators have reached levels last seen in the GFC of 2008-9

Chart 2 shows our US Composite Sentiment Indicator (CSI), which incorporates nine technical analysis and market breadth measures aiming to identify levels of exuberance and pessimism. As we can see, the CSI continues to languish around levels experienced during the GFC in 2008-9, when sentiment continued to remain at low levels for an extended period of time during the recession.

Chart 2: The US Composite Sentiment Indicator remains at extreme lows

Source: Wilshire, FactSet and Refinitiv. Data as of October 16, 2022

The pattern of subsequent market returns after reaching sentiment lows

Examining periods of statistically significant levels of low sentiment, Chart 3 shows that our US CSI has fallen below 2 (more than 1.5 standard deviations below the long-term average) thirteen times over the past fifteen years.  In the post GFC period, the US market has subsequently posted positive returns after the CSI falls below 2. However, we can observe this was not the case during the GFC, which was the last example of a prolonged recession.  

Chart 3: The returns delivered three months after hitting sentiment lows

Source: Wilshire, FactSet and Refinitiv. Data as of October 16, 2022

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October 3, 2022

Q3 witnessed a dramatic "U-turn" in risk appetite

The rapid reversal in risk appetite in Q3 has produced a retest of the June lows

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August witnessed a significant reversal in risk appetite mid-month in response to a succession of hawkish Fed guidance. This brought an end to the +18.6% two-month rally (and optimism) that started on June 16 and peaked on August 16. Since the mid-August peak, the FT Wilshire declined -16.7% over the remainder of the quarter to produce a -4.4% return for the three-month period. The strength of the rotation to risk aversion has now driven the index below the low point reached in mid-June.

Exhibit 1: A rapid reversal in returns over the last six weeks of Q3

One of the largest six-week drawdowns since 2006

Exhibit 2 puts the scale of the drawdown in US equities over the latter half of Q3 into perspective - showing that it is almost a three standard deviation event. Outside of the GFC and COVID sell offs, this is one of the largest six-week drawdowns since 2006.

Exhibit 2: Putting the six-week drawdown into perspective

The YTD drawdown of -24.9% is the sixth largest in 40 years

The YTD drawdown of -24.9% as of Sept. 30 is now the sixth largest witnessed over the last 40 years as shown in exhibit 3.

Exhibit 3: Putting the YTD drawdown into perspective

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October 3, 2022

The surge in the dollar is creating market distortions

A key feature of 2022 has been the sustained strength of the US dollar

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2022 has seen persistent strength in the US dollar aided by positive interest rate differentials, haven status and the perception the US is less exposed to the Ukraine invasion energy shock. Exhibit 1 shows the long-term performance of the DXY dollar index and the 16.8% YTD return has pushed the dollar back to levels not seen since the turn of the century.

Exhibit 1: The dollar is back to levels last seen over 20 years ago

The quantum of the appreciation of the dollar accentuates regional equity return differences

FX swings can have a large impact on unhedged regional equity returns depending on the location of investors. Due to GBP, Euro and JPY weakness, investors in the UK, Europe and Japan have a very different perception of regional market returns based in GBP, Euro and JPY versus the returns seen by a US dollar-based investor over both Q3 and YTD periods. For instance, it can be seen in exhibit 2 that UK unhedged investors (courtesy of the 8.2% decline in the pound) saw a positive return from US equities in Q3.

Exhibit 2: Comparing UK and US (unhedged) equity return profiles for Q3

The strength of the dollar is mitigating the impact of declining commodity prices

Most commodity prices are denominated in dollars. Consequently, when the dollar appreciates it offsets the impact of any fall in prices to non - US dollar-based participants (and vice versa). For instance, exhibit 3 shows that although the oil price declined 22% in Q3 in dollar terms, due to the depreciation of sterling, euro, and the yen against the dollar the oil price drop denominated in those currencies is more muted. The distortion of the move in the dollar on the regional oil price is even more extreme looking at two-year data.

Exhibit 3: The impact of the dollar on regional oil price moves

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