Valens Market Phase Cycle Monitor & Corporate Credit Macro View for February 2018

February 22, 2018

Market Phase Cycle™ Investing Strategy

Inflation will be a headwind to multiples, but earnings growth can be a tailwind

In the last month’s Market Phase Cycle, we highlighted inflation as a key risk that investors would be focused on as we moved through 2018.

Shortly thereafter, the market had a correction due largely to this issue and its implications for interest rates and equity investors. Inflation also is a negative for equity multiples longer-term because of its implication for real returns for investors. In essence, inflation leads to lower valuations in the long-term.

However, in the nearer-term, inflation is driven by a strongly growing economy that will facilitate earnings growth. Even if rising inflation causes market discount rates to rise slightly, that stronger earnings growth justifies higher multiples. The market is not yet pricing in that stronger earnings growth.

Sentiment indicators did not fully “wash out” in the market correction earlier in February, not yet giving an “all clear” for the market to move higher immediately. However, based on accelerating earnings growth, reasonable valuations, and safe credit risk, it continues to be a buy-the-dip market environment. As the report highlights:

  • Bear market cycles do not happen without a credit crisis. UAFRS-based fundamental credit risk is muted until 2020-2021. Lending surveys and charge-offs at an aggregate level also point to further credit creation in the near-term, not destruction
  • UAFRS analysis shows market valuations are not aggressive and earnings growth justifies upside – it is this strong earnings growth that is driving inflation
  • Investor sentiment is mixed – neither clearly positive or negative in the near-term – however, fundamentals warrant a buy-the-dip market if any re-test occurs

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