Note April 25,2018: Inflection Still Looms – In the equities, fixed income, currencies and commodities space of capital markets as well as in politics, whether raw or on trade. The Federal Reserve with a new Chairman has emphasis on reducing its massive quantitative ease, likely with other central banks at differing paces. Unlike say 1987, there appears no overt manipulation in major currencies but the relative stability in the U.S. dollar, Yen, Euro and Renminbi spaces seems ephemeral to us. Similarly, while 10 year U.S. Treasury Note yields are up 2 ½ times from their lows of June 2016 with BBB Corporate and Emerging Country fixed income aggregate yields at 12 month highs, more risky CCC Corporate yields are closer to 12 month lows. Losses in fixed income holdings have been building but sales may be occurring where possible rather than where needed.
Speak softly but carry a big stick well served statesmen like President Eisenhower and central bankers like Chairman Volker. Bluster without specific backup and subsequent backtracking accentuates the risk of miscalculations by adversaries. We see such subtext in French President Macron’s speech to Congress. We would be underweight fixed income and focus holdings on short duration. Currencies usually lead so their volatility could be latent. We see these political and currency issues as contributory to overweighting precious metals as an alternate asset in portfolios.
The efficacy of earnings beating consensus has deteriorated away from being informative. Currently, earnings management appears only exceeded by the penchant of dictators for over 99% approval ratings. More instructive, individual companies across industries and worldwide appear to be emphasizing that revenue competition remains intense. At present valuations, limited appear to be the margins for error for not being able to continually deliver double digit growth. Globally, so called market valuation gaps for Europe and Japan have much to do with Consumer Staples weights. We would also be wary of using arguments based on forward earnings based valuation comparisons against historical averages, which we stress are usually trailing earnings based. More equity selectivity appears in order over momentum and ETF stances. As financing conditions evolve, leadership from the Financials sector will be critical.
In the fixed income, currencies and commodities space of capital markets, a sustained inflection still looms but also with some surprises. One major development underscored by the IMF and other similar institutions has been improved potential for close to 4% annual global GDP growth, now broadened beyond the United States and emerging Asia. One more feature has been continued warnings in the analysis from the Bank for International Settlements, the Global Financial Stability of the IMF, the U.S. Congressional Budget Office and other institutions of the risks of leverage as financial conditions change. In its recent pronouncements, the Federal Reserve with a new Chairman has continued to its emphasis on reducing its massive quantitative ease. Other major central banks like the European Central Bank ( despite dispersion in EU country growth rates), the Bank of England (with its long history of monetary management), the Bank of Japan (with the longest period of quantitative ease) and the People’s Bank of China (with varied growth and provincial imperatives) seem likewise inclined, albeit at differing paces. We believe that the Federal Reserve is likely to have to raise Fed Funds higher than appears generally assumed. We target Fed Funds yields towards 3.50% into early 2019, with 10 year U.S. Treasury Note yields moving alongside towards 4.50%. Unlike say 1987, there appear no overt signs of manipulation in the major currency areas but to us, the relative stability in the U.S. dollar, Yen, Euro and Renminbi spaces seems ephemeral. Similarly, while 10 year U.S. Treasury Note yields are up 2 ½ times from their lows of June 2016 with BBB Corporate and Emerging Country fixed income aggregate yields at 12 month highs, more risky CCC Corporate yields are closer to 12 month lows. Losses in fixed income holdings have been building but it may be a situation of sales occurring where possible rather than where needed. We would be underweight fixed income and focus holdings on short duration.
Speak softly but carry a big stick well served statesmen like President Eisenhower and central bankers like Chairman Volker in their time in office. Bluster without specific backup and subsequent backtracking accentuates the risk of miscalculations by adversaries. It has been experienced in many political situations and financial crises. Representing a risk today is trade being dragged into the political arena wherein internal politics inevitably loom. In Europe, the economic stresses around Brexit and a lack of political cohesion emanating from southern Europe represent such issues of risk. In the United States and potentially leading to miscalculation, the precipitous tumult in the administration and in Congress ahead of its November 2018 mid term elections also represent internal stresses. Globally overarching with nuclear overtones are the conflagration encompassing the LeVant now expanding over Iran and the challenges in the Korean peninsula. We see such subtext in French President Macron’s speech to Congress on April 25,2018. He has systematically covered many issues from climate control to trade and general political relations. Many other multilateral and bilateral interactions loom involving the United States, not least with Korea but also with Russia and especially with China. Currencies usually lead so that increased volatility could be latent. We see these political and currency issues as contributory to overweighting precious metals as an alternate asset in portfolios.
Currently, equities are well into the thick of earnings and result reporting by companies, mainly but not exclusively in the United States. The deluge of earnings and result reporting is to shortly unfold worldwide. We believe an inflection still looms in the markets about the interpretation of earnings reporting. In many ways in this cycle, the efficacy of earnings beating consensus has deteriorated into rote manipulation and away from being informative. In prior cycles, the percentage and size thereof of earnings beating consensus would wax and wane, hence providing information value on business conditions. Currently, it would appear earnings management is only exceeded by the penchant of dictators for over 99% approval ratings. As individual companies report results worldwide, we find far more information value for investors to lie within corporate commentary. Not withstanding several quarters of earnings gains derived from severe cost cutting, capital restructuring not least derived from low interest rates and more recently, better economic growth globally, company management appears mainly to be emphasizing that competition for revenues remains intense. It appears to be the case, worldwide, across a broad swathe of industries from those of raw materials to those in manufacture (growth or otherwise) to logistics to those that are end consumer exposed (discretionary or staples) to those in finance. Earlier in the equity recovery cycle underway since 2009 and even when consensus was cut back drastically , quarterly earnings seasons were generally characterized by equity price gains. Since 2015 and into January 2018, it was especially accompanied by valuation expansion seemingly based on continued minimal fixed income yield competition. The reaction to early Q1/2018 reporting by companies seems to be more circumspect, despite consensus expectations for the S&P 500 group of companies of 18% annual operating earnings gains not being cut back. At present valuations, not being able to continually deliver double digit growth appears to have limited margins for error. We would be especially wary of using arguments based on forward earnings based valuation comparisons against historical averages, which we stress are usually trailing earnings based. Globally, Europe and Japan have been much touted as market rotation alternates for equity exposure at lower valuation. However, closer examination at the sector level would reveal that compared to the S&P 500, their so called market valuation gaps have much to do with Consumer Staples weights. More selectivity appears in order in equities than a momentum or even ETF exposure would deliver. As financing conditions evolve, leadership from the Financials sector will be critical.
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.