Cultivate the virtue of patience before returning to invest

• Stock market prices travel 10-15% above pre-Covid highs despite some recent adverse events

• The flattening of corporate profits, which began in March of this year, nevertheless seems to signal the approach of a slowdown in the cycle which, combined with the less accommodative policies of central banks, could trigger a reversal of the markets

• Before understanding that we can expect a rally at the end of the year and therefore decide to take new positions, it will be better to wait for the evolution of some factors, starting with the November quarterly

The growth of the financial markets, fueled by the overcoming of the health emergency and the restart of the global economy, has progressively brought the stock market prices to levels between 10 and 25 percentage point above their pre-covid high.; The European stock exchange is 12 percentage points above its pre-Covid highs, the American one 23. In September, the liquidity crisis of the Chinese real estate giant Evergrande (which some observers have associated with the failure of Lehman) and the dot plot of the Federal Reserve (FED), which highlights the expectations of a rise in interest rates, have sounded the alarm. However, the reversal of the markets foreseen by the analysts of investment banks has not yet taken place. Will it occur? And to what extent?

Considering today's prices, the chances of a significant reversal remain high even if the events mentioned were not enough to trigger it. Other and more solid reasons could negatively weigh on the markets' three to six months outlook. Some data, starting with the slowdown in corporate profits that began in March of this year, seem to indicate that we are approaching a mid cycle transition: the phase in which the economy continues to grow but a little less. If we add to this slowdown, the current orientation of central banks towards less accommodative monetary policies, it can be concluded that the expected reversal of the financial markets could be more profound and lasting than expected. Let's see in more detail, with the help of some data, the current trends and their possible evolution.

Since the beginning of the phase of market expansion, following the brief recession induced by the pandemic, the enormous monetary and fiscal stimulus has avoided the double dip recession that had occurred in 70% of past recessions. This post-recession expansion phase lasted much longer than usual, which leads to the hypothesis that the possible pause in the mid cycle markets could be marked (between 10 and 20%).

In recent months, many stocks have underperformed the indices. Initially this decline was attributed to the global spread of the Delta variant of Covid and its origin in the low quality of profits became clear.

It is also foreseeable that other factors, very evident in recent months and ignored by the markets, will make their weight felt. For example, the fact that the FED eliminated maximum accommodation (which happened in 1994, 2004 and 2011). In itself is a good sign because it indicates that things are going in the desired direction. It is still, however, one less support to the markets that may not take well to the absence of this protective net.

In general, the extent of the post-Covid recovery of the markets has been exaggerated. This implies that the mid cycle transition may be deeper than usual. We are not afraid of being on the eve of a double dip recession: we simply support the need to be patient and carefully evaluate the nature and impact of the current downturn before taking new positions.

The crucial step will be the quarterly season: in November, the results achieved by companies in the third quarter will give an important indication. In addition to understanding whether earnings will beat expectations or not, the relative expansionary strength of the various sectors of the economy must be carefully monitored.

The decision on when to go back to buying is also linked to the evolution of some technical factors (the learning revision pace or the moving average of the 50-day quotes), to the orientation of central banks (For example, if the FED was to start their tapering plan in November.) and to the economic policy decisions of governments (new fiscal stimuli in the States and in Europe). The combined assessment of these factors will tell us whether a year-end rally can be expected. In the meantime, it is better to cultivate patience, one of the seven virtues.

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