Note August 9,2019: Amid Volatility, Does the Bell Toll – At present, sovereign bond yields are low and in several cases negative. Daily stock market swings have turned intense, including sharp intraday losses converting into gains and then reversals the next day. Somewhat absent before in this cycle, currency issues loom currently between major economic zones. Political, central bank and market internal streams seem in gust. Amid volatility, it is worthy to ask whether the bell does toll.
Political dynamics seem unsettled in U.S./ China and British/EU relationships, with miscalculations apparent about the other side succumbing. After decades of foreign domination and now ahead of its 70th anniversary of power in October, China seems unlikely to be seen as bending to foreign pressure. Other stresses appear in Southeast Asia and from South Asia to North Africa.
Recent worldwide series of ease likely have a political dimension. The central banks could not afford to be seen as standing pat, irrespective of efficacy in comparison to 2008/9. Still, from capitalist to managed economies, state intervention into capital markets builds inefficiency. Amid negative levels for some sovereign issues, declines in bond yields need to be seen from safety/momentum rather than fundamental hues. Unlike prior decades, the arithmetic of compounding means that now, little margin appears for error.
Along with more sedate overall economic forecasts, companies point to severe competition for revenue growth and appear circumspect on capital spending. Share buybacks seem more contained, quantitative ease notwithstanding. Consensus has apparently favored consumer staples companies for yield and safety as proxy fixed income but some results demonstrate severe business pressures. With three quarters of companies seemingly routinely beating consensus, this metric may have limited value even as consensus appears reducing estimates for 2019 and 2020. Earlier, momentum could gain relief even from beating chronically lowered consensus.
Currently at potentially lower single digit or less in earnings growth for the S&P 500, even the quest for quality is likely to be more discriminating. Sectorally, in Financials we favor those earliest and most thorough in restructuring; in Information Technology, software and hardware over concept; as well as Healthcare and Energy over Consumer Staples and Utilities. Now in this cycle, increased currency volatility has entered into the politics and capital market lexicon. Not just the Renminbi but also European currency levels need watching, less so the Yen. For equity and asset mix, we espouse an overweight in precious metals and cash.
The political dynamics appear far from settled in China/U.S. and British/EU relationships, with miscalculations apparent on the other side succumbing. In politics, at the cusp in China of the 70th anniversary of ascension to independent power in October, it is worth recalling that the prior several decades had been ones of the physical and economic domination of China primarily by western powers. Currently and with this background, the leadership of China cannot afford to be seen as bending to foreign pressure. It would likely have domestic support thereof for a stiffer approach to pressure. It represents a fundamental difference compared to likely U.S. expectations that belligerence, including on trade, would lead to negotiations on U.S. terms as occurred with Japan in similar circumstances in the 1980s. Similarly, the new government in Britain appears to be calculating that the European Union would eventually be willing to negotiate at any price on Brexit by October 31, 2019. However, it is worth recalling that in the 1960s, Europe led by France did turn away from British exhortations. The latter was then reduced to pleading in the second half of the 1970s for formal ascension into Europe. Other stresses appear in Asia-Pacific and from South Asia to North Africa. In Asia-Pacific, stress appears not just over south China seas territoriality but also flowing from the history between the Korean peninsula and Japan that now seems directlyintervening into trade relations. As well, actual conflicts remain at risk from South Asia to North Africa, astride crucial trade and oil channels.
On further quantitative ease, led first by the European Central Bank and followed by a 25 basis point cut in the Federal Funds rate by the Federal Reserve, several other central banks have followed suit. Interestingly, the Bank of Japan has appeared less visible and economic growth there appears in some recovery. It seems to us that the most recent series of ease around the world have a political dimension for central banks. It relates not just to governments but is also about relations with the populace at large. The central banks could not afford to be seen as standing pat, irrespective of efficacy in comparison to 2008/9. The central banks undoubtedly do have a wide source of private and public information. Still and irrespective of interest rates, technological change affecting employment and wage prospects for instance cannot be dismissed as influences on growth, along with demographics. In addition to popular angst from the U.S. to Europe to Asia, politicians have been vocally critical of short term central bank policy, for example from the U.S. to India. However, from capitalist to managed economies, the long term evidence is preponderately that state intervention into capital markets builds inefficiency. With negative levels for some sovereign issues, the current downswing in bond yields needs to be seen as a safety/momentum rather than the fundamental hue that some have portrayed it. Unlike prior decades when reinvestment of income provided a cushion, the arithmetic of compounding means that now, little margin for error appears built in.
Heightened currency volatility among the major zones has become an increased probability as it enters the political lexicon, for instance and visibly with respect to the Renminbi. Among major currencies with Sterling succumbing to Brexit pressures, we would also be watchful for stresses extending into the Euro but less so over the Yen. They add another layer of credit quality concerns alongside the reporting of loosening of covenant standards.
In the last several weeks, companies have been releasing their latest results and corporate commentaries. Much like the overall economic forecasts from global institutions like the IMF and the OECD as well as ones within individual countries of slowing growth, companies point to severe competition for revenue growth and appear circumspect on capital spending. The issues of share buybacks also appear more contained than in the recent past, low interest rates notwithstanding. While investors have apparently favored consumer staples companies for yield and safety as proxy fixed income investments recently, some of the most recent aggregate corporate results demonstrate severe business pressures including among marque brands. With around three quarters of companies seemingly in aggregate routinely beating consensus, this metric may have limited value. Consensus appears reducing estimates for 2019 and 2020. At the start of this cycle when earnings percentage growth was much higher, momentum could gain relief even from beating chronically lowered consensus. In current circumstances, markets may be less so forgiving.
Currently at potentially lower single digit or less in earnings growth for the S&P 500, standards need to be higher and even the quest for quality is likely to be more discriminating. For instance, in Financials we favor those earliest and most thorough in restructuring; in Information Technology, software and hardware over concept; as well as Healthcare and Energy over Consumer Staples and Utilities. In addition, arguably for the first time in this cycle, increased currency volatility has entered into the politics and capital market lexicon. At the equity and asset mix level, we espouse an overweight in precious metals and cash. 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.