Note October 23 ,2019: Shifting Sands – Balancing Absolute versus Relative: In late 2019, the markets are likely experiencing the shifting sands of time, in particular on the balance between relative momentum expectations in vogue amid quantitative ease since 2009 versus absolute standards that do need to be addressed. In this regard, market internals as well as policy perspectives have import. Across the world much is in flux in politics from internally to trade. Resentment over the distribution of benefits from growth appears worldwide. The late year assessments in 2019 from many central banks as well as traditionally the OECD, BIS and the IMF indicate not just slowing growth but also financial leverage fragility. Internal unease appears in the institutions.
The high water mark of fixed income markets, likely was set when 10 year German Bund yields notched a low of negative (0.71%) in the summer of 2019 in continuum of the likely yield low of 1.36% for 10 year U.S. Treasury Notes in the summer of 2016. In the first three quarters of this cycle, there appeared greater coherence in fixed income yields working lower which in turn attracted greater lax into credit assessments. We see now instead, a need for increased scrutiny of currency, ability to pay for companies and countries worldwide.
In most of this cycle in equities, beating of consensus has appeared to be paramount. Instead and across sectors, we expect greater scrutiny to emerge on absolute delivery as indicative of the robustness of management and of financial strength. For the S&P 500, operating earnings are expected now to show modestly single digit annual decreases and at best slim gains. At the company level in the key U.S. equity market and globally, sharp bifurcation is evident within sectors. In fact for concept companies, in recent initial public offerings or aspirations of such, stress has developed. In banking worldwide and even after a decade of restructuring, the strongly financed and managed appear gaining over many others not just lagging but also strongly struggling.
Notwithstanding announced further quantitative ease, the global equity market reality seems currently one of a sideways correction underway since late 2018. Risks of pullbacks appear irrespective of whether or not overall consensus is exceeded. Business change implies greater selectivity favoring absolute delivery via business segment leadership and financial strength. Until recently, consensus preferences appeared to be for lower quality companies buttressed by suppressed administered rates.
Market internals as well as policy perspectives have import. Across the world much is in flux in politics from internally in many countries to international trade. Resentment over the distribution of benefits from growth appears worldwide. Budget deficits appear being given short shrift as policy imperatives. In the Americas, violence and fragility mark not just weak countries like Argentina and Venezuela but also Brazil, Chile and Mexico. As have many others in the world recently, the just concluded election in Canada resulted in losses for the governing party, albeit while still retaining a minority government. In the United States in addition to trade wrangles globally, impeachment and defense posture struggles exist in an already fractious election run into November 2020. In Europe, the struggles encompass not just Brexit by Britain but also wrangles from Spain to Italy to eastern Europe. More conflagration and great power moves appear in the Levant. Asia has not been immune to such country challenges and indeed about resentment over the distribution of benefits in its expansion in global economic heft. The traditional late year assessments in 2019 from many central banks as well as the OECD, BIS and the IMF indicate not just slowing growth but also financial leverage fragility. Further quantitative ease type policies have been introduced. However, in a significant shift, the extent of internal unease within these institutions seems now being voiced about both likely benefits even for near term growth and more importantly about the distortive effect being wrought upon efficiency in capital allocation.
In the capital market internals of many forms, momentum has appeared to be dominant for most of this cycle. Dominated by quantitative ease, new technology has appeared to abet reactions whether in the form of high frequency trading, ETFs or more traditional tactics based on short term, often daily assessments. However, we see change as being currently afoot. For the fixed income markets, it is highly likely that its high water mark was set when 10 year German Bund yields notched a low of negative (0.71%) in the summer of 2019 in continuum of the earlier likely yield low of 1.36% for 10 year U.S. Treasury Notes in the summer of 2016. New variants of quantitative ease especially in Europe and the United States appear not to have resulted in further lowering these benchmarks but instead appear to have accelerated range like behavior. Problem areas like Latin America in general loom again where haircut potential has emerged in weaker segments traditionally leading in such crises, like Argentina. Furthermore and in the below sovereign segment of fixed income, yields show stickiness at the lowest corporate rung in general. In some cases, severe stress appears as well. By contrast, in the first three quarters of this cycle, there appeared greater coherence in fixed income yields working lower which likely contributed to attracting greater lax into credit assessments. We see instead now, a need for increased scrutiny of ability to pay for companies and countries alike, worldwide. Currencies still have the ability to surprise.
Another season is underway of the release of corporate results and discussion thereof, classically starting in the United States. For most of this cycle, the beating of consensus has appeared to be paramount in equities. Instead and across sectors, we expect greater scrutiny to emerge on absolute delivery as indicative of the robustness of management and of financial strength of the companies concerned. The full impact of suppressed interest rates and asset purchases for quantitative ease took place amid the ramping up from the bottom in 2009 of earnings, alongside classically large year-over-year gains In the early to mid-stages of the recovery of earnings for the S&P 500. A global momentum focus on beating consensus gained some robustness.
Currently, we see change as taking place in a more moderate phase of the cycle amid also, lesser share buybacks that also set records earlier in this cycle. For the S&P 500, operating earnings are now expected to show modestly single digit annual decreases and at best slim gains. Sharp bifurcation at the company level is evident within sectors in the key U.S. equity market and globally. In fact, in the concept companies, amid those with recent initial public offerings or aspirations of such, stress has developed. In banking worldwide and even after a decade of restructuring, the strongly financed and managed appear to be gaining ground while many others seem not just lagging but instead strongly struggling in their core businesses.
Notwithstanding announced further quantitative ease, the global equity market reality currently seems to be one of a sideways correction, underway since late 2018. Risks of pullbacks appear, irrespective of whether or not overall consensus is exceeded. Business change implies greater selectivity in which absolute delivery via business segment leadership and financial strength counts for more. Until recently, consensus preferences have appeared to include lower quality companies buttressed by suppressed administered rates allowing both financial and business restructuring. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.