Opinion – From Grain to Grain: Forget the Brazilian elections, learn about the great uncertainty of the year for the stock market

Although many Brazilian investors discuss the electoral scenario and its impacts on the markets, this is not the great uncertainty that can shake the financial market. The biggest uncertainty is the inflation scenario in developed countries and especially in the United States and the reflection on American interest rates.

American consumer inflation reached the level of 7% accumulated in the last 12 months. A general rise in prices of this magnitude has not been seen since the 1980s. This can be seen from the graph below.

The remedy for this high inflation is already well known to us. We went through it last year and we’re still going to see it this year. Our Central Bank raised interest rates from 2% per year to 9.25% and this week it should raise another 10.75% per year, and may exceed 12% per year in mid-2022.

With this rise, Brazilian 10-year interest rates, used to price long-term assets, for example equities, rose to 11.5% per annum, from 7% in early 2021. This rise caused an average devaluation shares by around 20% since mid-2021.

This same effect can occur in the US promoting a similar correction.

In an article published on Bloomberg last Thursday, manager Greg Jensen of the renowned Bridgewater, which manages USD$ 150 billion, said that this movement in American interest rates could cause the S&P 500 to fall another 20% beyond the drop presented this month. .

According to Jensen, the US 10-year interest rate could reach the level of 4% per year.

The graph above shows the evolution of the 10-year interest rate, since 1972, on the white line. On the same chart, on the orange line, you can see the indicator called earnings yield (return of profit). This indicator is the inverse of the recognized price divided by profit (P/E) multiple. It would be equivalent to the “interest” fee received for investing in stocks if all earnings were distributed as a dividend.

Note that its evolution follows that of the 10-year interest rate. In other words, as interest rates fell, a lower return is required from stocks and so they could be traded at higher prices.

If long-term interest rates rise to the level of 4% per annum, the earnings yield could rise to 6% per year from the current 4.2%. That would mean the S&P 500’s P/E multiple would drop to 16.7 per year from the current 20.0, thus justifying Jensen’s expectation.

As can be seen in the chart above, the P/E multiple of 16.7 is exactly the long-term average for this multiple on the S&P 500.

It is important to understand that this scenario is not shared by the average of strategists interviewed by Bloomberg, who still believe that the S&P 500 could reach 4,900 points by the end of the year, that is, if it appreciates more than 10% by the end of 2022.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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