By Matein Khalid
The S&P 500 index trades at 2990 as I write. The risk-reward calculus on the broad index no longer flashes a buy signal to me. The economic data around the world has deteriorated at an accelerating pace, as the decline in global PMI’s, 9% fall in German factory orders and $13 trillion in in government debt trading at negative interest rates attest. Commodities prices are under pressure. The IMF has slashed global growth estimates. The liquidity situation in China (and Hong Kong) is downright scary. Second quarter EPS forecasts are far too optimistic in most sectors. We are entering the seasonal money losing quarter in US equities.
“An ounce of prevention is better than a pound of cure”. These words were spoken by Fed Chairman Jay Powell and they allude to his intention to cut the Fed Funds rate by 25 basis points as preemptive insurance at the July FOMC. Yet the Powell Fed’s rate cut reflect the risks of a synchronized global slowdown, and rising recession risk. The US stock market has priced in the Fed’s monetary ballast, Powell’s epic U-turn on interest rates since the January FOMC. The S&P 500 index now trades at 17 times forward earnings at a time when Eurozone is in a political and economic mess (the ECB’s next President is a French politician, not a German central banker) and US-China trade tensions are nowhere near resolution. My conviction that the S&P 500 index is a short here does not negate my belief that there is no shortage of undervalued companies and even sector ETF’s I can buy — but my love for a company’s stock is only at a specific price/value zone. I believe the NASDAQ composite is also overvalued at 8140 and faces a 20% correction in the next twelve months, down to 6400–6500. Why?
One, Microsoft has priced in excessive optimism on Azure margins and relative market share to Amazon’s AWS. Two, the slow down in iPhone sales and an anti-American consumer backlash in China is a fundamental drag on Apple shares. Three, the NASDAQ Composite index is trading at 22 times forward earnings, its highest valuation since 2004. This would be no problem if earnings growth in the next four quarters was going to be a blowout but, au contraire, I expect a mini-tech EPS growth recession — an earnings decline. The Philly Semiconductor index is flashing me “sell me, Matt” signals. My next targets for Apple is 174, Microsoft 120–122. Google 1060 and Facebook 176. What will happen tonight when Powell cooes easy money sweet nothings to the market and promises a July rate cut? Nasdaq will fly even a 100 points but this will be he last hurrah of an epic but very old and tired bull market.
Tech revenues, goosed by tax reforms, now faces ugly realities in China, Europe and even the US. Earnings on the large cap techs I track (and some smaller ones) will definitely disappoint consensus — and unleash waves of panic selling on NASDAQ. I could be wrong. As usual, time is the only judge. But what if I am right? What then?
So I seek special situations/turnaround ideas in Big Tech at the modest valuation that enable me to sleep at night. Dell and Oracle are my turnaround stories for 2019, as Cisco Systems and Facebook (post Cambridge Analytica) were for 2018. There is also money-making potential in media shares, a sector I love. We got Disney, Fox and BSky B right and made stellar profits for my prop book and for friends. CBS has been a bore/dead money but not for much longer!
Emerging markets have been in the cross hairs of contradictory macro forces in 2019. Trade tensions between the US and China have not been resolved, despite a Trump-Xi brokered truce at the G-20 summit in Osaka, Japan. The IMF has slashed its global growth forecast to 3.2% — and emerging markets have seen their own GDP growth forecasts fall from 5 to 3.5% in only six months. Yet emerging markets also benefit from a spectacular fall in US Treasury bond yields, with the rate on the ten year Uncle Sam note down from 3.75% last September to 2.01% now. Despite the 224,000 June nonfarm payrolls, the Federal Reserve has hinted that it will ease monetary policy at the July or September FOMC and the ECB’s next President Christine Lagarde will continue Dr. Draghi’s easy money policies. It is no surprise that the J.P. Morgan emerging markets local currency bond index has risen a stellar 8% to date in 2019.
This is not to argue that there are no disaster zones in emerging markets. The Turkish President just fired central bank governor Murat Çetinkaya for the crime of keeping interest rates at 16% to combat a 20% inflation rate. Erdogan believes high interest rates cause high inflation, a bizarre inversion of macroeconomic orthodoxy. He also believes that interest rates are the “mother and father of all evil”, definitely must have taken out a mortgage or credit card from a UAE bank!
Vietnam has become a target of the Trump White House’s ire for Hanoi’s role in acting as a front for Chinese, Taiwanese and South Korean exports. Samsung Electronics has warned about a 56% fall in profits due to the malaise in its semiconductor business. All is not hunky-dory in this best of all possible Panglossian worlds.
Yet, thankfully, Pakistan, Turkey and Argentina are mired in currency crises, are not the norm in emerging markets in 2019. No less than 30 emerging market central banks have cut interest rates in 2018–19, including such bellwethers as India’s RBI, China’s PBOC, Russia’s Bank Rossiya and the central banks of Brazil, Colombia, Thailand and South Korea. A fall in inflation means several emerging markets offer attractive real interest rate yields, notably Brazil, Mexico, Russia, Indonesia and India. Many emerging market currencies have been battered into cheapness due to King Dollar, a compelling argument for allocating funds to emerging market local currency debt.
True, emerging markets were boosted by the sugar high of a Powell Fed that flipped from hawk to dove on interest rates at the January FOMC and the plunge in the Volatility Index from 25 last December to 13–14 now. Yet if the US-China trade dispute erupts again, strong US payrolls/PMI data rules out imminent Fed rate cuts and enables King Dollar to go above 98 on its trade weighted index and China’s debt choked financial markets continue to deteriorate, the prospect of another emerging markets swoon this autumn becomes certain. A new spasm of risk aversion could well gut Wall Street, China and the major emerging markets.
A decade after Lehman Brother’s failure, the Federal Reserve still cannot “normalize” rates and significantly shrink its balance sheet. No deal Brexit, the rise of populism in Germany and the toxic Liga Five Star political coalition in Rome mean ECB President (select) Lagarde will cut the deposit rate to minus 50–60 basis points. These are all bullish omens for emerging market local debt as long as risk appetites, global liquidity and geopolitical risk stay benign. But then hope is not a strategy and woulda, coulda and shoulda is not the ideal prism for asset allocation.
Originally published at Arabian Post.