At the end of each year investment bank strategists make predictions as to the level that key market indices like the S&P 500 will hit in the coming year. The average across the major houses comes in at 5200, some eight percent higher than today’s level, with the highest above 5300 and the lowest at 4400.
The good, or bad news, depending on how you look at it is that there is typically a negative correlation between strategist forecasts and the high point in the S&P 500. Strategists are aware of this and many of them will rightly argue that their role is not to pinpoint the next peak in markets, and that this exercise is really a year end parlour game.
What is of interest is that the forecast PE (price to earnings ratio) deployed by strategists, and the market consensus PE is in the mid 20’s, a level that is historically high. In fact it is some 70% above the longterm average level and this in itself suggests that in the longrun (not a timing forecast) the valuation of the market may mean revert to lower levels, especially if interest rates rise and the Federal Reserve contracts its balance sheet.
This is not a forecast of a coming crash or wave of volatility but rather a signal that it may be difficult for headline stock indices to replicate the performance of 2021 and indeed that the risks are increasingly to the downside.
In this context, investors, as opposed to traders may need to look to different segments of the investment market in order to generate returns. At least three areas may be of interest.
One area is better hedging of portfolios or better, for experienced investors, adopting volatility strategies. Market volatility is typically higher when interest rates rise and when liquidity is withdrawn from markets. The issue here is that timing volatility spikes and expressing this in trades (often in the options market) is difficult and most investors will prefer to adopt simple hedges such as inverse ETF’s (exchange traded funds).
The behaviour of markets in 2021 was a continuation of earlier years in that market action was concentrated in a small number of megacap stocks like Apple. Indeed, the top five technology stocks make up close to 25% of the total market capitalization, the highest in nearly fifty years. This suggests that for portfolio managers the performance of the tech megacaps will be a large swing factor. The implication of this is that investors should use the megacap ETF’s to adopt a more tactical approach (on the upside and downside) to this central pillar in the market.
The PitchBook Economy
While much of the financial media fixates of the ‘democratisation of finance’ and the meme stocks that define it, there is another, almost opposite trend taking place at the other end of markets – the deepening of private capital investments.
This is defined by a quest by higher end asset managers, large family offices, well connected financial investors for access to non-quoted (e.g. venture capital, pre IPO stakes) investments in companies that are at the heart of technology driven sectors.
It might also be exemplified by differences in the tools of the trade. To a large extent the rise in equity markets over the past twenty years, and all of the wealth that has been created around them, is exemplified by the Bloomberg terminal. In the private capital world the tools of choice are ‘rolodex’s’ in the modern sense that private capital operators rely largely on trusted networks, and Pitchbook – an information service that provides otherwise hard to get detail on private companies (such as funding rounds, identity of shareholders, financial profiles).
The PitchBook economy thus centres around investments like venture capital, private equity and private debt. A large number of these investments are beyond the scope of retail investors, though some venture capital funds are accessible and for areas like fintech and green technology are interesting.
Investors will have to search beyond the S&P in 2022 to find solid returns.