by Philip Pilkington
Tuesday, 25
January 2022
Chart
07:00

The era of record company profits is coming to an end

2022 is looking set to be a very bearish year
by Philip Pilkington

Recent market jitters will have most investors nervous. On Monday, the S&P500, which tracks the broad market, closed at 4410, down from its peak by almost 8%. Meanwhile the NASDAQ, which measures high growth technology stocks, was hit even worse, closing at 13,855, down almost 12.5% off its peak.

It is always hard to figure out what drives sell-offs, but this one appears to have been pushed by investors worrying about inflation and rising interest rates in 2022. Every few weeks, the markets seem to raise their expectations of Federal Reserve rate hikes in 2022; in October the markets expected a single rate hike by the end of 2022. By early January, they were expecting three — and last week that was revised up to four.

The markets themselves are incredibly overvalued. Before the recent selloff, they were registering a reading of nearly 40 times on the popular Shiller PE metric — a reading that had only been beaten once before in history when, at the height of the dotcom mania, the Shiller PE went above 44.

That said, valuations may be a useful guide to what stock prices are likely to do over the next few years, but they are not good for assessing when that turning point will come — or even if it is already upon us. The best way to gauge the severity of the recent selloff is to compare it to other recent selloffs. Take the S&P500 first. Since 2012, we have 38 worse selloffs than the current one, but most of those occurred during the actual crash as the pandemic emerged in early 2020. If we are to exclude those, then we have seen 15 worse selloffs since 2012. So while the recent selloff is pretty severe, it is nowhere near record breaking relative to recent history.

The NASDAQ looks a lot worse. Since 2012, we have only seen 16 selloffs worse than what we have just experienced. But crucially, all 16 of these were in early 2020. This means that, if we exclude the market crash in early 2020, the NASDAQ is experiencing its worst selloff in the past decade. This is of particular concern because the recent market boom has generally been led by high growth tech stocks.

What is more, the three largest stocks on the NASDAQ have all taken a hit. Apple and Microsoft are marginally down, but Amazon is having a torrid time —its price has fallen nearly 23% in the past six months. This is due to post its fourth quarter earnings in early February, and markets appear to be factoring in bad news. This is likely markets waking up to the fact that the lockdowns are coming to an end and delivery services like Amazon can no longer rely on outsized earnings.

Some might counter this and say that lockdowns being lifted is good for the economy. This may be true, but it is unlikely to be good for corporate earnings. In fact, the lockdown has led to record corporate profits, as seen in the chart below. These profits have been driven by companies that have benefited from the lockdown.

There is some enthusiasm for stock in companies that were particularly hard hit during the lockdowns, like hotel and travel stocks. However, many of these companies had to load up on debt during the pandemic and might be particularly sensitive to rate rises. But regardless, they are just not big enough players to impact the overall market. The so-called FAANG stocks in the technology sector have a market cap of around $7.4trn; the market cap of the ten largest travel companies is just over $460bn or around 6% of the FAANGS.

In summary then, the evidence seems to suggest that two things are happening at once. On the one hand, markets are getting wise to the prospect of continued inflation and rate hikes in 2022. On the other, they are realising that many of the tech stocks leading the show are running out of steam as the world returns to normal. Is this the beginning of the end? That is impossible to say. But 2022 is going to be a hard year to keep the ever-shifting bullish narrative driving markets going.

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Mike Michaels
Mike Michaels
8 months ago

And I thought this piece was about vinyl.

Jon Redman
Jon Redman
8 months ago
Reply to  Mike Michaels

LOL, exactly what I thought.
Actual record companies are both the luckiest and the least appreciative of their luck out there. For as long as I have been alive, they have bellyached about how much money they lose to piracy. Yet in the last 50 to 55 years, they have been able to sell people the same product eight times over, because the format keeps changing.
So a Beatles fan in the 1960s has probably bought the same Beatles albums over and over again on most or all of:

  1. vinyl
  2. reel to reel
  3. minicassette
  4. 8-track cartridge
  5. CD
  6. MD
  7. MP3
  8. stream

and that’s excluding further sales in home video formats, which were unthought of in the 1960s; any exotic but short-lived formats such as DCC and SACD; and the thriving business they have in selling even the same CD twice, via the “digitally remastered anniversary edition”.
Throughout the whole time, all the record companies have done is complain. How much money would they have made if we’d never got past 1 – would it be more, or would it be less?
Part of why people of such modest talents as Elton John and Rod Stewart are so astonishingly rich has to be because of the repeat sales they’ve made through constant format changes.

Terry Needham
Terry Needham
8 months ago
Reply to  Jon Redman

I am toying with the idea of buying a cassette deck – A secondhand Nak would look really cool.

Jon Redman
Jon Redman
8 months ago
Reply to  Terry Needham

There’s a test on YouTube of a Nakamichi Dragon where the conclusion is you can barely distinguish it from CD. Because it had this monitor function, where you can listen to the quality of what you’ve just recorded, you can flip between a source CD and the Nak’s recording of it, to compare the two. Remarkably little difference apparently, which is no doubt why they still go for about two grand.

Terry Needham
Terry Needham
8 months ago
Reply to  Jon Redman

Trouble is that I have nothing to play on it. Anyway ‘er indoors is getting edgy. I admitted to having five turntables – two are on loan, two are in storage and one gets used to play music. I have crossed the line when it comes to overindulgence.
It could be worse I suppose. I could call myself Boris and have two on loan, two in storage and one to play with.

Last edited 8 months ago by Terry Needham
Jon Redman
Jon Redman
8 months ago
Reply to  Terry Needham

Oh go ahead. You know you want to.
I am not exactly sure how many MD players I have, either 3 or 4, but I have concluded that that what they are for is music on the go. There’s no point compressing six CDs to fit onto one MD. If I want rubbish sound quality, there’s MP3.
So I copy CD uncompressed to MD, and I can fit 2 CDs on one MD, mostly. On south coast beaches in summer and on Vienna streets in winter, I listen to Vienna and Rage In Eden, which fit uncompressed onto a single MD.
Buy a Dragon – or similar – and do the same. Make stunning copies onto CrO2 C90s tapes, one album on either side.
You’ll need to buy tapes and a Walkman. Go on. You know you want to.

Karl Francis
Karl Francis
8 months ago
Reply to  Jon Redman

Excellent piece, truly fascinating! Not sure what all that other guff in the main column was about? Pointless. I’ve just bought a Hammond L100, absolutely lovely it is! 1961, (Smug)

Jon Redman
Jon Redman
8 months ago
Reply to  Karl Francis

Whenever old school electronic acts like Jean Michel Jarre, Numan or Ultravox play live, the biggest challenge is often making modern synthesizers sound as good as analogue ones…

Lennon Ó Náraigh
Lennon Ó Náraigh
8 months ago
Reply to  Mike Michaels

That all-important missing hyphen!

Galeti Tavas
Galeti Tavas
8 months ago

You miss pointing out the real causes –

1) Zero Interest, this causes what is called ‘Being Pushed Out On the Risk Curve’. With any inflation at all – and you have Negative Real Interest. (now at 7-11%!!). (1.5 interest say in Treasuries or Gilts or completely secure bonds, but you have to keep in years them to get that) This means all your savings must be put into the stock market. Pensions – they are forced to very risky stocks or they will not meet their amount of income to pay out the pensions. Normally they would have a large amount in Bonds, but no real interest from them now. This inflates stock prices wildly – and so many (like me) are what are called ‘Retail Investors’ (sheep who know nothing so get sheered, but savings give zero interest so you had to gamble on stocks). Your life savings are melting like snow unless you stick them into risk – this is EVIL and is done by our governments fiscal and monetary policies.

2) Every month for years of $80 Billion QE (now tapering) and Fed buying 40 Billion in mortgage backed securities (tapering too). 12 Trillion money created for the plandemic of covid, all which had ended in the hands of the super wealthy inflating the market and hedge funds and hard assets. $100 Billion deficit spending, amount USA buys from other countries in excess of what we sell them….it just goes on and on.

3) Inflation. Inflation is a stealth tax on the regular people. It eats their savings and wages. The gov creates money out of air and spends it out. (to the wealthy ultimately, they had their wealth double during covid) Then there is more money chasing the same goods – unless productivity matches the money increase it means Inflation. (during covid productivity Decreased – making it worse) The government has debased the currency, which reduces the national debt in real terms, to pay it. – but you paid it, by inflation stealing your purchasing power.
All this is so far past recovering that there will be a crash unlike any seen – (so I believe, listen to Peter Schiff on youtube for regular, fun, analyst, he is a ‘Perma-bear and gold bug). And it is all the plandemic, it is all the WEF, IMF, Davos crowd – and it is the Great Reset. This is intentional.

Terry Needham
Terry Needham
8 months ago
Reply to  Galeti Tavas

Peter Schiff always sounds very plausible to me. Unfortunately I have no money to buy anything.

Vijay Kant
Vijay Kant
8 months ago
Reply to  Galeti Tavas

Capitalism rewards investors who take calculated risk; it punishes those who take reckless or no risk. Furthermore, in an uncertain world, governments are compelled to try unconventional policies. This means that discerning Investors should not rely on governments for their investment returns. Each investor is responsible for his/her investment regardless of what the government does.

Last edited 8 months ago by Vijay Kant
Warren T
Warren T
8 months ago
Reply to  Galeti Tavas

Perma-bears and Gold bugs have gotten crushed over the last 10 years. Sort of like an auto race where one car sits in the pits for 249 laps and then screeches onto the track during lap 250 and then claims he won the race.
There is no question that “corrections” take place in the stock market from time to time, but history has shown there is no better place for average folks to build wealth over time.

Katharine Eyre
Katharine Eyre
8 months ago

Yes, it’s a nerve wracking time for investors…but if you’ve piled a disproportionate amount of wealth into high growth tech stocks when it’s obvious the market is frothy and unsustainable and not diversified your portfolio or made some attempt to hedge risks, then you are a prize fool.
The best investors diversify, keeping exposures to risky stocks/instruments limited (and tied to their own risk appetite) and think long term. Trimming or restructuring a portfolio is sometimes necessary but trying to time the market and allowing yourself to get swept up in every trend or panic is a mug’s game.

J Bryant
J Bryant
8 months ago

I like this author’s articles. They appear to be Unherd’s one small nod in the direction of economics.
I do believe a severe crash is coming because (as other commenters have noted) there is a tremendous asset value bubble driven by ultra low interest rates.
Inflation is also upon us in a big way and the only way to tame that will be to raise interest rates substantially (much more than a couple of basis points). The medicine will eventually work but there will be a lot of failed businesses and unemployed people.
There’s no easy way out of our current economic situation, imo. We’ll have to hold our collective nose and swallow the bitter medicine of reduced asset valuations and high interest rates.
I challenge the author to write an article about the logic behind modern monetary theory embraced by the Democrats. How is it possible to endlessly print money without real world consequences?
I also challenge the author to look into the future: does he think a major correction is coming with much higher interest rates to tame inflation? How will the global economy react? Is there a less painful way out of our current economic situation? Are we on the cusp of a new Great Depression or the beginning of a more prosperous era?
I’ve noticed economists hate making predictions. Most are, in effect, economic historians who describe what has already happened today or fifty years ago. That’s what happened after the 2008 financial crisis; lots of fine articles describing what happened, but where were these clever economists before the crash? Why didn’t more of them predict it?
From an economic perspective, where is the world headed, Mr. Pilkington? Persuade Unherd to give you a full-length article and tell us about the future.

Justin Clark
Justin Clark
8 months ago
Reply to  J Bryant

The shift from Gold to Fiat is very significant… highly recommend this talk – https://www.youtube.com/watch?v=s_VbDp_bq2w