Note January 8,2019: Checks and Balances Overdue – Well beyond politics, checks and balances seem overdue. They include the behavior and pricing of capital markets. In politics, checks and balances are still to gel in trade, in the Middle East cauldron with a new focal point of Syria, around Europe, in east Asia and not least between the United States and its allies as well as in its domestic post-election stresses. In current capital markets, checks and balances appear as being dismissed as secondary to central bank policy or as being difficult to incorporate and hence only an afterthought. Nothing could be further from reality. In nature and for that matter for well-trained engineers, redundancy exists precisely because sources of uncertainty cannot be pinpointed with accuracy in advance.
Ignored when hubris occurs as investment cycles mature, there is reason in capital markets for similar redundancy via risk or uncertainty premiums. Only a decade after the last debacle, a feature of this investment cycle has been collective market memories appearing to be purged of such considerations, apparently assuaged by prolonged low administered rates.
A new stream of corporate reporting has started and more will gush forth. Due to their being residuals from revenues accrued after expenses have been paid out, corporate earnings are an especially volatile series not just in recessions and appear far from certain even in growth. It remains so despite the global impact of massaging of company results and the U.S. corporate tax cuts of last year. Instead, the quality of recurring earnings is a key to valuation. Instructively, prolonged zero interest rates have hardly helped many industries in Japan maintain leadership. Fast leadership change resounds about smartphone manufacture. It has long been vicious in going from the U.S. to Canada to Finland and back to the U.S. then to South Korea and now seemingly China. It is also instructive across industries worldwide that ignoring the investment need for risk premiums can be costly. We reiterate the need for focus on quality in operations and financial structure strength as well as, cash reserves in asset mix as well as on Financial Services for market leadership.
In the capital markets of today, checks and balances appear as being dismissed as secondary to central bank policy or as being difficult to incorporate and hence to be treated as an afterthought. Nothing could be further from reality. Precision about the exact source of stress is in practice impossible in advance. In this era of quantitative ease since 2008 and for that matter in the decade before, it appears widely accepted that reactions should legitimately occur after the fact, or as commonly known after the bubble bursts. Such examples would include that after the 2000 technology, media and telecommunications debacle or that after the credit debacle of 2008. Not to be outdone and unlike theory, equity markets peaked only after earnings had peaked for the S&P 500 in 2000 and then again in 2006. We do not consider such behavior as inevitable. In the 1980s into the early 1990s for instance, without precise pinpointing, volatility and uncertainty premiums were present in capital markets in recognition of uncertainty.
In nature and for that matter for well-trained engineers, redundancy is widely incorporated in design precisely because the sources of uncertainty cannot be pinpointed with accuracy in advance. Ignored when hubris occurs as investment cycles mature, there is reason in capital markets to incorporate similar redundancy, commonly known there as risk or uncertainty premiums. Only a decade after the last debacle, a feature of this investment cycle seems that collective market memories appear to be purged of such considerations, apparently assuaged by prolonged low administered rates.
A new stream of corporate reporting has started and more will gush forth. Not just in recessions and being far from being certain even in growth, corporate earnings are an especially volatile series due to their being residuals from revenues accrued after expenses have been paid out. It is so despite the global impact of massaging of company results and the U.S. corporate tax cuts of last year. Instead, the quality of recurring earnings is a key to valuation. Drilling further down and instructively, prolonged zero interest rates have hardly helped many industries in Japan maintain leadership. In point of fact, the loss of leadership for Japanese industries has been broad during this period. Many companies from basic industries to manufactured goods and even into growth sectors, quality scandals have also surfaced.
Globally and not to be outdone, once more, conglomerates have defied theory and not been able to finetune their component industries. In growth segments worldwide, in mainframe computing since the 1940s, leadership swung from Britain to the United States to a broader range of countries today. Fast leadership change currently rears about smartphone manufacture. It has long been vicious in going from the U.S. to Canada to Finland and back to the U.S. then to South Korea and now seemingly China. Technology companies from the United States and South Korea have issued revenue warnings. It is likely broadly instructive across industries worldwide that ignoring the investment need for risk premiums can be costly. Rather than 10% plus being the normality for annual S&P 500 earnings, it has been closer to 7% which seems insufficient for us to consider 16x earnings to be inexpensive for the S&P 500.
In politics, several checks and balances are still to gel. They are inevitable in trade and have the most direct impact on business prospects for companies and countries alike and hence for capital markets. In the formulations of relations around the Middle East cauldron, a focal point has become Syria where geopolitics as well as regional rivalries are being played out. Around Europe there are the geopolitics to consider versus Russia. Relations within the European Union are hardly sedate not just about British exit or eastern European expectations but also within treaty stalwarts like France, Germany and Italy. In east Asia related to China and North Korea as well as and not least relative to its allies, the United States has much to consider as is also the case about its domestic imperatives.
We reiterate the need for focus on quality in operations and financial structure strength as well as, cash reserves in asset mix as well as on Financial Services for market leadership.
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.