Beware of the bear. With indices down 5% a few days ago, there are clear signs that there is still plenty of selling capacity in the markets, despite the fact that the current regime of rising rates and fighting inflation was probably incorporated. for some reason, US investors just want to keep hoping the Fed will pull back. They probably won’t. What they’ve done so far hasn’t worked, and jobs keep getting added, and people are getting more and more jobs. The Phillips curve is back, and that means we have inflation and we will continue to have it until people start losing their jobs and we face real misery. When the monetary authority wants misery, eventually you will get it. So why do US markets and indices like the iShares Global 100 ETF (NYSEARCA: IOO) long before 2019, the pre-disaster era? It shouldn’t be. US markets are far from their potential bottom. At best, the indices trade sideways and are hit by inflation for a few years. It’s a void bet.
The IOO is technically a global value-weighted ETF. But with anything weighted by value, the winners are usually a dominant proportion, as in all winning systems. The technology has taken the market over the past two decades, and the United States being the birthplace of the technology means that the United States ultimately leads the IOO with a 74% allocation. In other words, the “Global” means little.
Indeed, it is a typical value-weighted US ETF on top of the odd foreign exposure. In fact, IOO’s sector distributions are quite similar to those of the iShares Core S&P 500 ETF (IVV). The command is the same.
At the top of IOO are all the usual suspects. FANG stocks, Microsoft (MSFT), etc.
Let’s do a quick economic review. The first is the recent inflation report, which saw an increase in underlying inflation. This was actually quite obviously going to happen due to the employment data from a few weeks prior. Unemployment had increased, but only because more people were participating in job search. The number of jobs in the economy has increased and employment has clearly increased, hence the acceleration in the pace of underlying inflation. Because inflation is spreading, it has to be brought down and the market has understood that rates will rise further. The 5% drop the other day was the result of market participants, for some reason, still believing the rate hikes weren’t going to last long.
The fact is that inflation is a propagating and persistent force. it may have started due to cost pressures, but it now has a mind of its own. The economy must cool down and misery must be introduced for inflation to subside. In other words, LTM earnings overestimate our future.
IOO trades at around a PE of 16x, while pure US IVV trades at a PE of 20x. The differential comes from foreign exposures that seep into IOO and reduce exposure to high-PE US equities. This implies an earnings yield of 6.2% on an LTM basis. Lower on a FWD basis assuming earnings fall overall, which they will. This means a minor deviation from benchmark rates, which will climb past the 10-year yield of 3.5%, to around 4% or a bit more assuming another 75 to 100 basis point rate hike. base. This means that IOO does not really offer a risk premium. Enough said, don’t buy it – there’s still a long way to go.
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