By Eric Lynch, managing director of Scharf Investments
What a difference a year makes. This time last year, we were telling everybody it was story time in America – the better the story, the better the stock. Just a year later, it seems investors are waking up with a hangover.
A year ago, we had monetary and fiscal stimulus that was in excess of 50% of GDP. Now, monetary and fiscal stimulus is waning, and interest rates are increasing blisteringly quickly. That is a set of conditions we have not seen since the 1980s.
Investors now face a set of different conditions. Before, the fed could save us with impunity, because there was no negative consequence from their monetary stimulus levels. Now, that consequence is being felt acutely in inflation, and consumers’ pocketbooks.
Because of that, we have had a major contraction. The S&P started the year at 26x, and it is now at about 16x. However, we would argue there is still another leg down, and that is margins.
Margins for the US corporate sector are at almost twice their long-term average, and a lot of factors that were previously tailwinds have become headwinds, including low labour costs, low input costs, low energy costs and low interest rate expense.
Therefore, we think the current margins that are baked into consensus of 10-20% above pre-pandemic levels still have room to fall, and earnings consensus is too high. Quite frankly, we do not think we have capitulation, even in valuations. There is no bigger investment oxymoron than the fact there are 1,000 ‘unicorns’ – businesses valued at more than $1bn – still present in the US.