Weekly Market Review 4th May 2019
In this Issue
. Tech Bubble ?
. Stronger US Dollar Ahead
. Global Growth is Weakening
. The Week in Review
Tech Bubble ?
Say what you want about the technology earnings season but, as we expected, the beat rate was down, Intel and Alphabet took lumps, and chipmakers ailed to quiet critics.
Nevertheless, technology stocks remain the darlings of investors and the sector is up 33 percent in the first four months of the year with another strong day just recorded yesterday.
The Nasdaq 100 has now risen an unprecedented 18 times in the last 19 weeks and going back 93 years, the only other time it had a run like this was in June 1957.
The Nasdaq 100’s market cap vs S&P 500 is now approaching dot-com highs. However, technology profits are much higher today than they were then.
Is this the second leg of the tech bubble ?
It’s fair to ask the question , given how big that index is getting versus the rest of the market. At about 36 percent of the S&P 500, it’s creeping up on 1999-style dominance. Arguing against the comparison is the share of overall earnings its companies generate. Going by the quarter they just reported, it’s four times as much as 20 years ago.
Sure, Facebook is at war with regulators and Google’s advertising shortfall left analysts baffled. With $90 billion of net profits in the first quarter the FAANGS remain money-making machine even if profit growth is no longer there.
Altogether, Nasdaq 100 companies earned more than $460 billion in profits last year, a 9-fold increase from the peak year of the internet bubble.
The question that begs to be asked is whether we have reached the peak in earnings and/or in earnings growth for these companies and their business model.
The one thing that has changed over the past couple of years in that in 2017 they were all growing sharply, justifying high valuations. Today some of them find it difficult to grow more or even avoid declines but valuations are still flirting with 100x earnings in some cases.
Four weeks into reporting season, tech profits are expected to fall 6.8 percent in the January-March period, on course for the worst quarter since 2009.
Among tech companies that reported, earnings have beaten estimates by 6 percent, below the average of 6.5 percent over the past two years. The scorecard on sales is worse, with the beat margin reaching 0.5 percent, versus 1.5 percent historically.
Investors responded with a yawn. With results from five of the largest U.S. companies in, Alphabet was the only one to see its stock fall the day after its earnings, but companies like Netflix and Amazon failed to rise substantially despite good numbers. Apple Inc’s results were carefully massaged but remained unimpressive altogether.
Growth is deteriorating as products such as smartphones have entered a maturing phase and parts makers like semiconductor companies have seen weak demand from a range of end markets including data centers.
Bubble or not, investors refuse to fall out of love with tech.
With $2 trillion added since Christmas, the Nasdaq 100 has a shot at beating the market for the 10th time in 11 years.
Only three American companies have ever been valued at $1 trillion and they’re all in the index: Microsoft, Apple and Amazon.com. And two of them reached that valuation last week.
At least two Wall Street strategists downgraded tech stocks last month, saying this year’s market-leading rally has stretched valuations to extremes and is unlikely to last. Noah Weisberger at Sanford C Bernstein & Co. called the stocks “unjustifiably rich.” Sean Darby at Jefferies said the group may have run ahead of fundamentals.
Doug Ramsey, Leuthold Group’s chief investment officer, has likened the persistent affection for tech stocks to the 1990s internet frenzy. In a note published in early April, he warned investors to watch out for the risk of crowded stocks unwinding should everyone start to exit at the same time.
At 36 percent, Nasdaq’s market value as a percentage of the S&P 500’s still sits above its relative profit share of 29 percent, indicating a higher price-earnings multiple.
The End of Tech ?
Shorting the Trillion – Dollars companies
As our investors know we have called the End of the Technology sector in 2018 and have shorted some of the key players in the industry in our Model Portfolio.
Our case is not based on the quality of the companies involved, which are superb industrial corporations, but on the unsustainable extremes in valuation and participation reached.
This is what bubbles are made of and although valuations have come down slightly from their peaks, they are still high for the prospects of the industry at large.
Technically, the uptrend in place since 2009 has clearly been broken in the 4th quarter of 2018. The sharp downdraft usually indicates a difficulty to reach new highs and the completion of a lower high before the bear market really starts.
Last week we made new all-time highs in both the SP500 and the Nasdaq indexes. They either indicate the start of yet another vertical leg up, or they are part of a more complex double top marking the end of the bull market.
To get a clearer picture, It is interesting to take a closer look at the results, behavior and configurations of our individual short candidates; the Trillion dollar Companies and their fellow FAANGS.
Google Inc.
lousy results sent the stock tanking -6.98 % last week and the chart seems to indicate a massive double top as well as the end of the bull phase that started in January 2019. The stock is highly overbought on the MACDs and on the RSI indicators.
Microsoft Inc.
MSFT reported better than expected results and the stock went flying. However, to put things in perspective, earnings were up only 6 % and revenues only 8 % when compared to last year.
Does that justifies 27 x earnings of the company and almost US$ 1 trillion of valuation implying a 10.82 X Book value?
The stock is in a vertical acceleration and clearly overbought on both the MACDs and the RSI
Amazon Corp.
AMZN’s good results with 25 % increase in earnings on 17 % increase in sales were not sufficient to send the stock flying. AMZN rose 0.61 % last week after a spectacular 40 % advance since December. There again are a 72 x P/E and 20x book value justifiable with these growth rates ?
The stock is highly overbought on both MACD and RSI and could well be marking a double /
lower top.
Facebook Inc.
FB surprised the market with much better results than expected by the market, sending the stock shooting up. However, Earnings were up barely 12 % when compared to the first quarter of 2018 and the full year earnings for 2019 are expected to be down 4 %.
Paying 27 years of earnings and 6.5 times Book value for a company that delivers 10 % or even negative growth in earnings may be a bit stretched.
The stock is highly overbought on both MACDs and RSI.
Apple Inc
Tim Cook performed a spectacular exercise of investor’s expectations massaging the year/
He made analysts and investors happy with a 10 % decrease in earnings year on year in March and little substance in terms of where the next wave of growth will come from.
Paying 18x earnings and 9.3x book value may prove to be expensive if the Trillion Dollar company’s earnings growth settles in the low double digit range. Is the world saturated with iPhones, tablets and Mac computers? Are competitors like Huawei increase their share of the promising Chinese, Indian or Indonesian markets? Are Apple products too expensive at this stage of their life cycle ?
Even is the company uses its 100 Bln+ pool of cash reserves to buy its own stock 9 times more expensively than book value, then that cannot be deemed profitable in the future.
The stock is overbought on both MACDs and RSI.
Netflix Inc.
Right ! Does paying 111 years of earnings ( yes 111x P/E ) and 29 Times book value for a company that delivers 30 % growth in earnings and revenues make sense ???
The market seems to consider that NETFLIX’s services will never have competitors ( Apple ? ) and will continue to penetrate new markets at the rate it has done in the past despite the saturation of the US market and the elevated costs of going after foreign markets.
We doubt it ! NFLX trades 100 % higher than where it was in Jan 2018 !
Advanced Micro Devices
AMD’s earnings were better than expected but, still, 45 % lower than last year. The company’s data center chips are posting strong sales growth and share gains against Intel, aiding sales, gross margins and EPS. However, AMD’s near- zero-market share starting point in servers has aided sales and margin.
AMD’s 45x P/E is highest among peers and is probably not justified by the 8 % earnings growth expected for 2019.
Clearly the consensus expects an extremely strong recovery of AMD’s product cycle but with a Price to Book at 17x, these expectations are fully priced-in.
The stock has almost trebled since January 2018.
There is nothing more difficult than calling the top of a bubble and the end of a sector that has inflamed the imagination of investors for a full decade.
However, history is there to prove that excesses do not last and the Trillion Dollar companies are today where the .dotcom stocks were in 1999.
Stocks and sectors should always be sold at the peak of their earnings cycle and valuation.
The spectacular rebound of the technology sector over the past 4 months is giving investors a last chance to bail out.
These stocks will trade much lower by year-end.
A STRONGER US DOLLAR AHEAD
As we have been writing in several of our posts, we expect the US dollar to make more headway in 2019, completing the last phase of the secular bull market that started in 2014 and that we rightfully called then.
We haven’t been surprised by this year’s rise in the US dollar against other major currencies but have been disappointed by the lack of magnitude of the rally so far.
One of the reason may have been investors’ dovish reassessment of the outlook for Fed policy, which, at first glance could look negative for the US Greenback. As we highlighted in our Post – The FED pauses, BUY the US dollar – what drives currency rates is real interest rates and their differentials.
Despite its pull-back last week, we expect the greenback to appreciate further this year, even as rates fall by more in the US than investors are anticipating.
One gauge of the US dollar’s trade-weighted value against seven other majors is the Fed’s Advanced Foreign Economy (AFE) Dollar Index. This includes the currencies of the euro-zone (38.5%), Canada (28.1%), Japan (13.2%), UK (10.6%), Switzerland (5.5%), Australia (3.0%) and Sweden (1.1%).
In the past, a rise in the AFE Dollar Index has often coincided with an increase in the gap between 2-year overnight indexed swap (OIS) rates in the US and a trade-weighted average of the economies in that index.
This occurred between 2012 and 2016. Since then, though, the relationship has been weak.
This year, for example, the index has risen to a two-year high, even though the gap has fallen.
There has been a broad-based breakdown in the relationships between exchange rates and interest rate differentials so far in 2019. The US dollar has risen against the krona, franc, euro and yen, despite the 2-year OIS rate dropping more in the US than in Sweden, Switzerland, the euro-zone and Japan.
And the US dollar has fallen against the Canadian Dollar, despite the 2-year OIS rate declining a bit more in Canada than in the US! Only in Australia and the UK has the usual relationship held.
This puzzle can be largely solved by taking account of two other developments in the year to date.
The first is a recovery in equity prices. This has reduced demand for the franc and the yen, which are considered to be even safer havens than the US dollar.
The second is a rebound in the prices of some commodities. A higher oil price has boosted the Canadian Dollar, while a higher iron ore price has underpinned the Australian Dollar, which explains why it has fallen a lot less against the US dollar than the shift in rate expectations would imply.
Until now, investors have not yet focused ion real interest rates. And history shows that there is a 6 to 9 months timely between shifts in real interest rate differentials and foreign exchange rate moves.
Looking ahead, we don’t think that monetary policy will exert much of a drag on the US dollar over our the next 12 months.
Admittedly, we forecast that the Fed will cut rates by the end of the year and by more than investors are now anticipating, as economic growth in the US disappoints. – Our Deflation scare scenario-.
Our expectation is that US interest rates will be reduced by 50 to 75bp between now and mid-2020 and then stay at 1.50-1.75% until the end of 2020. The rates that are currently implied in the markets in mid-2020 and end-2021 are roughly 2.15% and 2.00%.
But we also think that monetary policy elsewhere will generally remain very loose, or even be loosened further.
One key element of our scenario is that Oil prices are about to collapse taking inflation rates down across the board. As a consequence, real interest rates will increase sharply in the US, and in any case much faster than in the rest of the world where nominal rates are at zero.
In the euro-zone, for example, our view is that the ECB will undertake another round of quantitative easing next year, as inflation remains uncomfortably low.
Our global scenario is that economic growth will slow sharply in the US and stay sluggish in the rest of the world, apart form China.
We expect a slump in the prices of equities and commodities later in the year as deflation becomes again the main concern.
Safe-haven flows and higher bond yields will probably boost the US dollar against other major currencies and in particular the EUR, the CHF and the JPY, until equity markets really start falling in the 3rd quarter.
History shows that the US dollar rose in the last two US recessions, as well as in the milder economic slowdown of 2015/2016, which more closely corresponds to our scenario for the economy.
Overall, we expect the US dollar to continue to strengthen on a trade-weighted basis this year, but to weaken next year.
In our view, this will occur largely in response to fluctuations in investors’ appetite for risk, rather than to changes in their expectations for interest rates.
This message is reflected in our forecasts for exchange rates. We forecast that the US dollar will rise against the euro from around 1.12/€ now to 1.05/€ by the end of this year, before falling back to 1.15/€ next year.
We see the Japanese Yen breaking put of its triangle above 112 with a target of 120, before recovering to ¥110 in 2020.
The CHF could rally short term, but weaken substantially later in the 2nd quarter of the year.
GLOBAL GROWTH IS WEAKENING
Economic data from earlier in the year and a range of business surveys pointed to a further slowdown in the world economy in the first quarter, but global GDP growth looks to have surprised on the upside.
China’s economy fared better than expected, in part due to a quick pass-through of monetary easing to the real economy and a front-loading of fiscal stimulus. But growth was also propped up by a build-up of inventories and strong construction activity, both of which we expect to go into reverse and weigh on growth in the second quarter.
Similarly, Q1 GDP growth in the US was lifted to a surprisingly high 3.2 % in Q1 2019 by volatile expenditure components, while underlying domestic sales weakened considerably.
Growth in the euro-zone area will be reported next week and may also have benefitted from a couple of one-offs.
So, the world economy has got off to a reasonable start in 2019, however we still expect global growth to remain sluggish this year and, in fact maybe even next year.
To sum top the indicators that have been released to date :
• Output and activity indicators show that GDP growth rose in Q1 in advanced economies
.• Business surveys suggest that global manufacturing is still struggling.
• Household consumption continues to recover gradually from a weak end to 2018.
• World trade is set to contract again in Q1
• Leading indicators point to continued weakness
• Labour markets have begun to lose some vigor as labour demand is easing
• Monetary indicators are accommodative
• Inflation has picked up due to higher oil prices, but core inflation remains stubbornly low.
• Commodity prices generally fell in April, but oil got a boost from tougher US sanctions on Iran.
• US Financial markets are in bubble territory, with the S&P 500 and the Nasdaq at a record high.
Global Activity
Global GDP growth appears to have been considerably stronger in the first quarter than previous monthly data led us to fear. We estimate that world GDP growth picked up from 2.9% annualized in Q4 to 3.1%.
We thought that advanced economies slowed in Q1, but in fact they look to have accelerated, driven by stronger-than-expected growth in China and in the US. Net contribution of other advanced economies to growth in Q1 was zero, particularly Japan.
The weak spot among advanced economies is Japan, where the latest activity data point to GDP contracting by 0.6% q/q in Q1. Indeed, industrial production fell by almost 1% in March, more than reversing February’s partial rebound from a dreadfully weak outturn in January.
In the US, while overall GDP grew strongly in the first quarter, industrial production and consumption fell slightly.
China’s economy fared better than the market expected in Q1 due to a quick feed-through of policy easing, with growth in most accepted measures of Chinese activity staying at a minimum of 5% annualized. The Government number based on other inputs atet are not always publicly available surprised the markets at 6.4 % annualized.
GDP growth also looks to have been flat elsewhere in the Emerging Economies. Stronger growth in Latin America and Turkey’s early exit from recession offset weaker growth in Asia. However, in year-on-year terms the EM slowdown continued in Q1.
Business Confidence
In March, Markit’s global manufacturing PMI was unchanged at 50.6, lifting hopes that the global manufacturing sector was on the verge of a turnaround. But in April, the PMI fell again to 50.3, which is consistent with world industrial production growth slowing to just 1% y/y .
Industrial production is the weak spot of the world economy as the Trade War uncertainty led CEOs to refrain from making new investments or running high inventories.
A drop in the emerging economy PMI outweighed a small rise in the index for advanced economies. But this did little to reverse the outperformance of Emerging Markets so far this year.
The biggest source of encouragement in previous PMI surveys had been the rebound in China. But both the Markit and official China PMIs dropped back in April, underlining our view that risks to near-term growth are stacked to the downside and that China needs a lasting solution to the Trade War.
The Brexit boost to the manufacturing sector in Q1 reversed in April – the UK PMI fell the most among major economies.
While the US manufacturing PMI ticked up in April, like its ISM equivalent it points to a continued contraction in manufacturing output. The flash composite PMIs for the US and euro-zone fell in April.
While the surveys understated the strength of advanced economies in Q1, they do suggest that growth will weaken in the second quarter, and even below 1%
Consumption
Private consumption has continued to recover from the disappointing end to 2018 but is likely to slow over the course of this year. Retail sales volumes in advanced economies have increased, but not by enough to reverse December’s sharp fall.
US Consumption halved from 2.4% to 1.2% annualized and the figures should come out next week for Europe and Japan,
In year-on-year terms, consumption growth has been on a gradual downward trend for four years, matched by a similar deceleration of house prices.
Resilient growth of total labour incomes has underpinned near -2% consumer spending growth during this period. But as jobs growth slows and wage growth flattens out in the coming quarters, real worker compensation is likely to drag on spending growth.
In some cases, we also expect more fragile consumer confidence to prompt households to save more. The euro-zone is a case in point, where consumer confidence fell again in April, having already fallen a long way during the past twelve months.
The ECB’s latest bank lending survey already reports weak demand for consumer credit in the euro-zone and points to slower consumption growth ahead.
Finally, retail sales growth has picked up sharply in China but has continued to slow elsewhere in the Emerging Economies.After a partial rebound at the start of the year, world trade volumes fell again in February – the fourth drop in six months. They fell by 1.8% m/m, following a downwardly-revised 2.1% rise in January.
World Trade
After a partial rebound at the start of the year, world trade volumes fell again in February – the fourth drop in six months.
They fell by 1.8% m/m, following a downwardly-revised 2.1% rise in January.
Exports from emerging economies and exports of electrical and electronic goods were especially weak. The slowdown in world trade can be seen in weaker air freight volumes. International air freight fell about 1% m/m in February and in each of the three previous months.
Meanwhile, freight volumes transported by sea have fared comparatively well and are still growing by more than 2% y/y.
Trade volumes may have recovered slightly in March, with early-reporting Asian export growth consistent with an almost 1% y/y rise in world trade. However, more forward-looking indicators suggest that world trade will continue to lose momentum in the months ahead .
Labour Market
Labour markets in advanced economies have begun to lose some of their recent strength.
While US non-farm payroll employment rose strongly in April, aggregate employment growth in G7 economies slowed sharply from around 1.5% at the end of 2018 to just 1.0% in March.
Jobs growth has held up well in the UK and Canada in the first quarter, but we think that Q1 marks the peak in both cases.
Slower jobs growth has not yet been enough to push up unemployment rates. In fact, the euro-zone unemployment rate fell to a post-2008 low in February. However, surveys indicate that employers are less upbeat about hiring prospects, suggesting that unemployment rate should soon start ticking up.
G7 job vacancy growth has slowed during the past year and especially so in the US in recent months.
Surveys are also suggesting that labour shortages faced by firms in the US, UK and euro-zone are starting to ease. As labour markets continue to play catch-up with the general slowdown in economic activity, we expect wage growth to stop accelerating, or even to ease, adding momentum to our Deflation Scare scenario for the second half of the year.
Monetary Indicators
Money and lending data are actually a bright spot I n the global picture and testify of the very accommodative nature of Monetary policies globally.
Broad money growth edged up again in all the major advanced economies, but even in Japan it stabilized at around 2%.
Growth in lending to firms remains fairly resilient throughout advanced economies. However, within the euro-zone, corporate lending is still falling in Spain and Italy for the time being. The latest surveys show that most banks in the euro-zone relaxed their lending standards to firms in Q1, while banks in the US have begun to restrict the availability of credit.
Bond issuance by non-financial corporates in advanced economies continued to pick up in the twelve- months to February, thanks to low interest rates and a tightening of credit spreads.
However the sharp fall in the US points to a renewed fall in issuance in March. In contrast, leveraged loan issuance in the US rose but remains at a lower level compared to a year ago, reflecting the higher cost of borrowing
Inflation
Average OECD headline inflation increased to 1.7% in March from 1.5% in February, primarily due to an increase in energy prices. We expect oil prices to drag on inflation over the rest of the quarter and start falling sharply in the second half of the year.
As a consequence, energy prices should exert some disinflationary pressure in the coming months. By contrast, core inflation in OECD countries edged down from 1.7% in February to 1.6% in March.
Core rates fell in most major advanced economies. The euro-zone flash estimate for April bounced back up to 1.2%, but this was due to Easter timing effects that are likely to be reversed in May.
US core CPI inflation eased to a 13-month low of 2.0%, and labour cost data for Q1 suggests that the current downward trend is likely to continue.
Aggregate emerging market inflation accelerated from 3.2% in February to 3.5% in March. A significant proportion of the increase was driven by China, where headline inflation jumped from 1.5% to 2.3% as pork prices rose sharply on the back of supply disruptions caused by African swine flu.
Elsewhere, inflation in Argentina climbed to a record high of 54.7% in March, and the renewed pressure on the peso will push inflation a little higher in the next few months before peaking later this year
Commodity Prices
The prices of most commodities fell in April, with the notable exception of oil.
The US administration’s decision not to renew sanction waivers on Iran’s crude exports sparked fears of a tighter market and pushed prices briefly through $75 per barrel. However, technically, oil prices marked the first significant peak in April.
We believe that Oil prices will fall in the rest of this year as global growth disappoints and supply increases everywhere. Indeed, there is plenty of spare capacity among OPEC members and we expect the Venezuela crisis to end before June 2019, bringing a clearly negative bias to supply.
Aluminium prices fell sharply in April, reflecting persistently strong Chinese exports and production.
Gold sold off, reflecting a rise in risk appetite that also hit demand for other safe havens, and the strength of the US Dollar. But we expect this trend to reverse before the summer.
The price of wheat slumped as favorable weather pointed to bumper harvests. However, the USDA still estimates that the market will move into a deficit, which may ultimately put a floor under prices.
In a nutshell, global economic conditions are not improving yet and will not for as long as the sword of the Trade War lingers.
Monetary policies are accommodative for now but the sharp fall in oil prices that we expect may take Central Banks by surprise and cause a sharp Deflation Scare in the second half of the year.
When that happens, risky assets will fall sharply and Gold will rise, together with safe heaven currencies.
• THE WEEK IN REVIEW
CURRENCIES
The US dollar weakened slightly last week but the configuration remains positive for the Greenback as long as the DXY Index remains above 97.5.
The CNY is hesitating ahead of the last round of negotiations to be held next week before a closing summit between XI JinPing and Donald TRUMP around the 15t May 2019
EQUITIES
Global equities are still up this week but are losing momentum. Optimism is at record highs and hedge funds are more short volatility than they have ever been in years.
The US earnings season is ending and there is not much in terms of catalyst to propel equities higher.
COMMODITIES
Oil recorded its first weekly SELL signal last week as Donald Trump called on OPEC to lower the price of Oil and US inventories and production data reached record highs.
Iran’s sanctions should have limited impact and the Venezuelan crisis should find a solution rather quickly.
Palladium started the second leg of its bear phase.
BONDS
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