Note November 4,2018: Salient Divergences from Past. The to-and-fro swings in equity markets and an unmistakable rise in fixed income yields from their cycle lows indicate a salient channel of divergencies from assumptions that until recently were commonplace in capital markets. A new level of uncertainty in Europe has been injected with a series of German state elections underscoring a populist anxiety. After vociferous mid-term electioneering that encompassed high immigration, trade, tariff and protectionism voltage but had little to say on deficits, the United States is likely to be at the cusp a new phase. Violence and strife appears with new avenues in the Levant. Still, politics and populism is not the only salient divergence from the past for the markets to consider for late 2018 and into 2019.
Despite above global growth in large population emerging countries like China and India, a decade of low interest rates and quantitative ease continuing in advanced economies (albeit now being tapered by the Federal Reserve), the ongoing worldwide releases of corporate delivery show a notable set of divergences even within sectors. Another salient aspect recently has been that amid moderating global growth and quantitative ease in the initial stages of taper globally and more so in the United States, yields in the fixed income markets are now being recorded again at closer to 12 month highs but this time also with CCC corporates being frog marched along. We believe it to be a question of time before higher yields are recorded in many sovereign bond markets.
We agree that corporate delivery divergences have not been just a recent phenomenon but in fact have been underway for several months. Still, changes in fixed income markets and the elevated valuation of equity markets are likely to make such divergencies subject to heightened investor response. The ebb and flow of corporate reporting has been in current play in the United States and is likely to remain in play as reporting expands throughout the world, from Consumer Discretionary to Information Technology to the Financials to name but a few. These divergences in revenue guidance can be discerned within and among most sectors and among most geographies. We believe more selectivity is likely than was complacently espoused at the apex of quantitative ease when focus was intense by many professional and individual investors on risk on/risk off or ETF rotation and on many other investment tactics
The politics of populism have not been expunged. Violence and strife appears with new avenues in the Levant. The continued machinations in Britain about Brexit and the spate of state elections in Germany demonstrate that angst is not confined to the southern and eastern regions of Europe where populism is epitomized by governments in in Hungary and Italy. Greater Russian pugnacious behavior can be seen from arms control to border vigilance to renewed objectives of gaining allies. The same appear in the policy objectives of the U.S. administration from Iran sanctions to relations with NATO allies to tariff tactics in relations with China. After vociferous mid-term electioneering that encompassed high immigration, trade, tariff and protectionism voltage but had little to say on deficits, the United States is likely to be at the cusp a new phase. Still, politics and populism is not the only issue for the markets to consider for late 2018 and into 2019.
No change in administered rates in Europe, Britain and Japan were reiterated recently. They should not be taken as continuation of a status quo long present in capital markets. Despite above global growth in large population emerging countries like China and India, a decade of low interest rates and quantitative ease continuing in advanced economies (albeit now being tapered by the Federal Reserve), the ongoing worldwide releases of corporate delivery show a notable amount of divergences even within sectors. Another salient aspect recently has been that amid moderating global growth and quantitative ease in the initial stages of taper globally and more so in the United States, yields in the fixed income markets are now being recorded again at closer to 12 month highs but this time with CCC corporates also being frog marched along. We believe it to be a question of time before higher yields are recorded in many sovereign bond markets.
We agree that corporate delivery divergences have not been just a recent phenomenon but in fact have been underway for several months. Still, changes in fixed income markets and the elevated valuation of equity markets are likely to make such divergencies subject to heightened investor response. The ebb and flow of corporate reporting has been in play in reporting towards the end of 2018 in the United States and is likely to remain in play as reporting expands throughout the world. The divergences within and among sectors can be discerned as well in corporate guidance across many geographies. In Communications Services, the redefining of footprints and of increased oligopolies appears not to have alleviated pressures. In the media content portion likewise, delivery appears far from uniform in recent reporting. In Consumer Discretionary and a buoyant consumer notwithstanding in many advanced and emerging economies, apparel retailers including those from Europe whose global supply chains had previously served admirably have now been less than buoyant. Shopping malls globally appear with overcapacity. Luxury retail reporting appears to include aspects indicating that it is no longer sufficient for growth to expand from catering to the wealthy and to the aspirational consumer. Not just tariffs but also profitability have appeared bifurcated in automobiles in North America and Europe with reporting in Asia from major Japanese companies and in China likely to be closely scrutinized. In Consumer Staples, the bifurcation of results even among sellers of toothpaste with long established brands underscores that rising incomes appear not to be lifting all boats.
In Energy and not withstanding crude oil prices at over twice the levels of recent lows, strongly managed and large integrated companies my appear with strong results but in exploration and smaller production companies, some results have been flaccid. In the Financials, years of restructuring and quantitative ease still show differentiation as underway in the United States. The strength of the German economy has been no panacea for issues that have been long overlooked in its banking sector. In India, fears of directed lending have expanded from agriculture and now to nonbank financials that in this cycle, have become overexposed to real estate. Provincial finance and credit overexpansion remain issues in China. In Healthcare after close to a decade of M&A, ostensibly old fashioned issues like patent expiry, pricing and drug efficacy could be seen in recent reporting from generic and brand companies alike even as political pressures rise on pharmaceutical pricing policies. Cost of care appears also looms as a revenue growth issue in services companies.
In Industrials, for a wide swath of companies based in the United States, Europe and Japan, the management acumen of existent businesses has been a chronic issue with conglomeration again under a cloud. In Information Technology, long established companies have in their releases commented upon fast paced change as exacerbating revenue bifurcation. In Materials, unilateral declarations and threats of further tariffs have reared as general issues of business concern in agriculture and basic industrial materials, severe restructuring notwithstanding. For the REITs, issues likely to raise more differentiation appear already in the taming of price gains in financial centers and in retail space that were not long ago considered stable such as shopping malls. For Utilities even as the cost of capital evolves with tapering quantitative ease, addressing requirements for climate change are likely to be continued business differentiation issues.
We believe more selectivity is more likely than was complacently espoused by many professional and individual investors in recent years at the apex of quantitative ease in the form of risk on/risk off or ETF rotation and in many other investment tactics.
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.