Note July 10,2019: Valuation versus Meeting Consensus as Market Driver – Investing requires a broader context than momentum, whether at the country or company level. Capital market valuation is elevated. Consensus growth was cut and low for example for S&P 500 earnings and declining for global economic growth. Meeting consensus as market sufficing has likely also reflected also, momentum trading driven by ultrafast data ingestion. Unlike appearances so far in this cycle, valuation and delivery of growth being seen as more secondary to the meeting of consensus is likely to become less lopsided.
For these reasons, we peruse recent semi-annual commentaries such as from the Federal Reserve, the IMF and the Bank for International Settlements. Over a decade ofU.S. quantitative ease does not seem delivering overall stronger growth compared to Australia and Canada without it. Neither has more extreme quantitative ease such in Japan and Europe been demonstrably more efficacious than that in the U.S. Unlike market behavior, regulators cannot vacillate daily on rate policy but currently seem uneasy and circumspect on quantitative ease building collateral risk. One such is via leveraged lending in portfolios, public and corporate finance structure. Crosscurrents appear in Federal Reserve July 2019 semiannual testimony. In emerging and advanced economies alike, higher political interlocution on monetary policy appears while central bank leadership itself is in flux. It can be seen with countries as disparate as Argentina, Mexico, the United States, Italy, Turkey and India being instances.
It means that by markets and authorities alike, dislocations may only be acknowledged after the fact. Additionally, global politics and trade remain tense. Many issues make diversification and reserves all the more important in portfolios.
Semi-annual but weighty releases from central banks offer perspectives beyond those present in their other more frequent pronouncements. Most recently has appeared the July 2019 Federal Reserve semi-annual testimony to Congress. It has appeared to emphasize crosscurrents ranged from trade to weaker global growth leading to more uncertain corporate investment. By contrast, its February 2019 testimony appeared to emphasize a stable U.S economy growing annually around 2 ½ % in GDP with employment gains and inflation only slightly below a benchmark of 2%. A more circumspect Federal Reserve has seemed to have led to almost daily changes in market expectations about Fed Funds rate trends.
The 2019 annual and economic statements of the Bank for International Settlements (BIS) released at the end of June 2019 do highlight more contributions worldwide from fiscal and infrastructure initiatives as being crucially additional to monetary measures. The BIS alludes to the risks of building side effects from prolonged quantitative ease and the contrary flow pressures that can build from low international interest rates versus currency forces for countries such as emerging ones with higher external funding requirements. Earlier, both the IMF and the OECD have appeared to signal slower global GDP annual growth as being closer to 3 -3 ½%. It likely means that servicing debt with the heightened leverage lending of this cycle could easily lead to stress for companies and countries alike were present condition stability prove ephemeral over time.
Much like Greece and other southern European countries benefitting from lower interest rates on entering the Euro two decades ago, fiscal conservatism has not been uppermost in public finance today. It represents a form of collateral risk from quantitative ease that is both unclear and in line with classic political behavior when immediate crisis is absent. Meanwhile in the Americas, Europe and Asia, higher political interlocution appears in emerging and advanced economies alike while central bank leadership itself is in flux. In countries as disparate as Argentina, Mexico, the United States, Italy, Turkey and India, such events can be seen as recent instances.
The travails in country and financial institution financing in Europe already demonstrates that leverage stress is likely not being limited to those for emergent countries or for unseasoned companies. Over a decade of U.S. quantitative ease does not seem to be delivering overall stronger growth compared to Australia and Canada without it. Nor for that matter has more extreme quantitative ease such in Japan and Europe been demonstrably more efficacious than that in the U.S. Unlike market behavior, regulators cannot daily vacillate about rate policy but seem uneasy. Central banks also appear hesitant in being upfront about problem areas. One such risk likely lies in extended leveraged lending being of collateral risk that emanates from quantitative ease were low rate stability prove to be ephemeral over time.
Investing needs a broader context than momentum, whether at the country or company level. Capital market valuation is elevated. Consensus growth expectations have been cut and are currently low, for example for S&P 500 earnings and declining for overall global economic growth. In the fixed income markets, negative yields have expanded into several European sovereign benchmarks, most notably but not limited to German bunds. Low quality fixed income yields for companies have also declined. Meanwhile, reported expansion appears in covenant light issuance which raises debt servicing risks linked for instance, to leveraged lending.
Much exposure has been focused on the size and purchases of sovereign fixed income by central banks for quantitative ease purposes. Currently obscure additional risk likely also resides in private areas like portfolios and ETFs or mutual fund structures with links to corporate and public finance. Also less clear is the extent to which developments like negative sovereign bond yields have developed as a result of their being used as base upon which to leverage up portfolio yield by adding in leveraged low quality issuance. The same could be an occurrence that has been driving up funds for private equity and special purpose vehicle finance. Such concerns have had limited exposure but some central bank (such as the Bank of England) and private sources starting publicly to highlight risks to liquidity assumptions with respect to non-bank financials.
Meeting consensus as market sufficing has been reflective of the extent to which momentum trading driven by ultrafast data ingestion has impacted capital markets. The company earnings cycle did start from a very low base in 2009. From this base, a momentum based reaction to meeting consensus appeared. Initially as occurs during recovery from a bottom, the main consensus revisions had to do with the degree of amplitude of the earnings recovery. Currently exists a much slower earnings expansion environment. Markets seem mesmerized by response to meeting consensus, however low. Despite low administered interest rates and low fixed income risk premiums, the early reports of corporate results for Q2/2019 appear to reflect still stiff revenue competition and delivery challenges as continuing. Unlike appearances so far in this cycle, valuation and delivery of growth being seen as more secondary to the meeting of consensus is likely to not to be as lopsided going forward.
It means that by markets and authorities alike, dislocations may only be acknowledged after the fact. Additionally, global politics and trade relations remain tense. In the already inflamed Levant, appear U.S. and Iran tensions. In Europe there are Brexit issues with respect to the United Kingdom with additional other tensions in continental Europe amid European Union leadership change. In Asia, trade relations of the U.S. with China appear hardly settled and the same is true about nuclearization on the Korean peninsula. Many issues make diversification and reserves all the more important in portfolios. 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.