In our view, the market response to the Evergrande’s troubles is a form of confirmation bias, the human tendency to aggregate information or “facts” into what must certainly happen next. In this CIO Bulletin, we assess the worry points impacting investor’s thinking:
• One worry is that US equity valuations are “too high”. While US valuations are among the world’s highest, they have been propelled by record earnings that have legitimized this year’s stock performance. Even in the face of a small US corporate tax rate hike, the next two years are likely to see operating profits rise by 7-8% per year in the US and globally. Looking back over 73 years of data, US equity total returns averaged 10.8% in the 12 months after an early-cycle growth peak. Returns were positive in 8 of 9 of those periods. In the sec
• “Never ending” COVID is another concern. COVID infections remain high in the US and world at large. In the Fed’s comments this week, they noted that, “the sectors most adversely affected by the pandemic have improved in recent months, but the rise in COVID-19 cases has slowed their recovery.” But the fact is that the pandemic is generating less and less restraint on overall economic growth as people and businesses adapt.
• Anxiety over high taxation killing the economic recovery also persists. But we expect that the passage of any legislation will result in manageable changes in taxation for US corporations. The rise in taxes may have less impact that the face value of 5.5% when allowing for tax offsets that the current proposals contain. We also believe that it is more likely than not that the debt ceiling debate will not generate the market turmoil last seen in 2011.