M.I.C.E Updated

We’ve written previously about the M.I.C.E. framework that Foord uses as a temperature gauge for share markets. With global bourses now in bear market territory, portfolio manager RASHAAD TAYOB revisits the framework to test current market levels.

Foord uses a high-level four-factor framework called ‘M.I.C.E.’ to gauge market levels and assess where they might be headed. As a macro strategist new to Foord, I quite like the simplicity of the framework. It focuses on four key factors and excludes a lot of subsidiary variables and noise. M.I.C.E. stands for Money for the Markets, Interest Rates, Confidence and Earnings.

Money for the Markets describes the quantum of liquidity that is available to buy into share markets. Liquidity is heavily influenced by central bank policy, specifically the volume of quantitative easing or tightening. Central banks pumped record amounts of money into the global economy during the height of the COVID-19 lockdowns. This money is now gradually being withdrawn, but slower than expected in some areas. This is a headwind to asset price recovery.

Interest rates are key drivers of market levels because they set the cost of borrowing. Rapid and globally synchronised rising interest rates this year means less money will flow into financial assets. Markets are expecting the benchmark federal funds rate to near its mid-2000s peak of 5% by year end. More importantly, the 10-year US Treasury real yield — the yield after deducting inflation — is now above 1% after languishing at -1% for two years. This level resulted in big market selloffs in 2013 and 2018. Further interest rate rises will be very negative for share markets.

Confidence describes risk sentiment or the animal spirits of the market — it determines how much companies and consumers are willing to borrow, spend and invest. A glance at the daily financial news suggests that there is no shortage of things to worry about. We can see this in the portfolio positing of global fund managers: more fund managers are underweight shares than was the case during the 2008/9 Global Financial Crisis. Confidence is low, but investors are not yet panicked.

The fourth factor is earnings. In our view, earnings are the most important driver of long-term equity returns. We need to understand where we are in the economic cycle and assess where we are still headed. Corporate earnings collapsed during the pandemic but rebounded rapidly on government handouts. Earnings are now above their long-term growth trend. The withdrawal of government stimulus, rising interest rates increasing the cost of borrowing, and rising inflation putting pressure on margins are all headwinds to corporate earnings.

In summary, there will be less money for the market as central bank pandemic stimulus unwinds; interest rates have already increased a lot, but global central banks are still fighting inflation and aggressive dollar strength, so there might be more to come; confidence is poor but not rock bottom; and corporate earnings are enjoying post-stimulus buoyancy and are cyclically high, with risks to the downside.

We are therefore still cautious, even after the significant market falls this year. We remain invested in quality companies with a low weight to cyclical sectors. We expect there to be some good buying opportunities in the months ahead.