Stocks rose 2% last week, led by the Nasdaq ($NSDQ100).
There are two scenarios for the stock market over the next 12 months, depending on what happens to the economy.
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In this scenario, the economy slows significantly this year and next, but avoids recession.
This scenario was recently analysed by KKR, who believe the US economy will grow 2.4% in 2022 and 1.3% in 2023, while inflation will drop from 8% to 4%.
Under these assumptions, KKR believes the $SPX500 could finish 2022 at 4200 and increase to 4350 next year. That means about 10% potential upside over the next 18 months.
The upside is limited because higher interest rates and higher inflation both act to compress equity valuations. Last year, when the 10-year Treasury yield was at 1%, investors were happy to pay 20x earnings for stocks. Since then, the 10-year interest rate has increased to 3%, and as a result, the fair multiple for stocks has decreased to 17x.
In this scenario, the economy enters a shallow but prolonged recession.
Earnings collapse, especially in the cyclical sectors.
This is not yet in the price, although the $NSDQ100 is getting close.
In this scenario, targets for the $SPX500 in the 2900-3150 range are reasonable.
The conclusion we draw is that in the soft landing scenario, the upside for stocks is relatively limited, while in the recession scenario significant downside risk remains.
Historically, when central banks were increasing interest rates and global credit growth was slowing (the current situation), the best investment was USD cash.
Therefore, we mostly hold USD cash – not EUR, GBP or anything else – and wait for central banks to become more accommodative, at which point much more money can, we expect, be made.
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The share of cash in the portfolio was increased to 75%.