Covington Investment Advisors, Inc. Blog

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Taking the Temperature of the Market

There is no shortage of indicators used by investors to gauge where the market is going in the short term but many are unreliable at best, and the ones that are attested usually get arbitraged out over time. In our last note we mentioned that historically when the market enters bear territory we are closer to the end of a drawdown rather than a beginning. But the selloff so far this year has been relatively orderly. The VIX, also known as the “fear gauge” is an index which uses S&P 500 options pricing to derive the expected volatility of the overall market. When the VIX is high that usually indicates that there is an elevated level of fear among investors signaling the market may be near a low. This low in the market typically coincides with a spike in the VIX above 40 which we have yet to see but...
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Cleaning Up After the Party

In a note last year ‘What Happens When the Punch Bowl is Taken Away’ we used the common analogy in the economic world of central bank stimulus withdrawal being similar to a punch bowl being pulled away at a party. Since that note inflation has not only stuck around but accelerated way past our expectations, and evidently the Federal Reserve’s. Fast forward to now and the punch bowl has not only been pulled away but cleaning up is beginning at the party. Yesterday's much anticipated Federal Reserve committee meeting resulted in a policy rate hike of 75 bps, the biggest since 1994, and a stark contrast to the ultra-easy monetary policy coming out of covid. What's more is that the central bank is going from quantitative easing (pushing cash into the economy) to quantitative tightening (pulling cash out of the economy) in a short period of time. The Fed is...
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The Adjustment Period Continues

As we progress through the recent volatility I believe the market is pricing in the higher rates that the Fed is implementing with anticipated acceleration. That being said, I do not believe the market has fully adjusted to the effects of rampant inflation, the effects of quantitative tightening just being implemented, nor the anticipated earnings revisions as a result of these challenges. Bearish sentiment will continue until the Fed moderates policy. Accordingly, I think the capital markets will remain volatile for the next few months. Once the Fed eases up on the pace of tightening, China fully opens up, and/or inflation is reasonably tamed, the market will settle into a more historical valuation multiple. Pending the overall market reversion we have been holding back from investing our large cash balances. There are now however some individual stock names that have reached attractive earnings multiples and I feel comfortable dollar cost...
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Era of De-Globalization

  Beginning in late 2020 when writing our 2021 Economic Outlook we tried to deduce what the longer term scars might be from the covid pandemic after the waves of the virus are behind us. In our mind the most likely shift would be a reordering of the global supply chain to onshoring which we coined “The Era of De-Globalization”. This was perhaps lazy because this trend had actually been in place before covid as world trade peaked in 2009 and has been slowly reversing since. Nevertheless, at our Pike Run Event in December 2021 we again highlighted de-globalization as a tail risk to the economy in the form of a geopolitical affair. Admittedly the event we had on our mind was a Chinese incursion in Taiwan, but instead we got the abrupt Russian invasion of Ukraine in February. Why this is disruptive is because the post-WW2 world was shaped...
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Market Valuation and Volatility

  With the dramatic compression in valuation multiples this year we can now start to plot the current positioning of the market versus historical averages to gauge whether or not equities are attractive. On the graph above I have the forward 12 month P/E ratio of the S&P500 which currently stands at 17.6x and represents a level of 4,029. Overlapped on the chart I have 5, 10, and 15 year average multiples along with corresponding S&P 500 prices. The current fwd P/E ratio of 17.6x is below the five-year average of 18.6x which gives a fair value of 4,231.5 using consensus forward EPS estimates of $227.5 for 2022. However, the market is still above the 10 and 15 year average multiples of 16.9x and 15.6x, respectively.These longer term multiples give S&P 500 fair value levels of 3,844 and 3,549 which correspondingly represent -4.59% and -11.91% drawdowns from today’s prices. As...
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Covington Investment Advisors, Inc.
301 E. Main Street
Ligonier, PA 15658
Phone: 724-238-0151
Fax: 724-238-0148