Wed 06 November 2019
Finding Humour in the Markets
Greece can now borrow money cheaper than Trump’s America, leaderless people’s movements are raging in countries as far as apart as Chile and Hong Kong, there is no resolution yet to Brexit as we hurtle toward another election, trade war Tweets and impeachment hearings are all you read in the press, Elizabeth Warren is rising fast in the democratic polls, and yet the market continues to march higher – even making new highs. If nothing else, the market gods seem to have rediscovered their sense of humour!
While there is much to worry about (which we cover in greater
detail below), tactically, I find it tough to be too negative. Here
are a few reasons why:
■ Trump may be a lot of things, but he knows that if he needs
to get re-elected, the US cannot go into a recession in 2020.
There is a lot that can still be done to ‘juice’ the economy
(constant pressuring of the Federal Reserve (Fed), a minor
trade war resolution, payroll tax cuts, fiscal stimulus for
infrastructure build, and so on).
■ While 2021 estimates seem too high, we seem to have passed
the worst of the earnings downgrade cycle for FY2019/2020
and, as the recent earnings season has shown us, cyclical
stocks are no longer going down on bad news, and some are
actually going up on bad news. (If stocks don’t behave the
way consensus expects them to behave on bad news – take
notice.) As one of our US portfolio managers commented on
Caterpillar earnings (ticker: CAT): ‘CAT did not behave like a
DOG post results!’
■ The Fed and the European Central Bank (ECB) have decisively
shifted from quantitative tightening to quantitative easing.
Broad liquidity and money supply growth has rebounded
in most parts of the world and especially in China it has
stabilised – when things go from bad to less bad, good
things happen in markets!
■ Lead indicators (OECD, for example) seem to have bottomed
out, and while there is no steep re-acceleration, at least things
are not getting worse.
■ Employment in the US remains at pretty high levels and whilst
company indicators would suggest that we are already in
the midst of an industrial recession, given the strength in
the US consumer, it is tough to imagine we are in the midst
of a broad-based US recession, as some commentators
■ While there is no hard data to back this (yet), when we look
at industrial orders (machine tool order series), companies
(like investors) have gotten so defensive (run down their
inventories) that even the smallest hint of positive sentiment
could trigger a significant inventory re-stock (which tends to
be a powerful driver of sales and margins) – see what has
happened to Apple orders and supply chain as wait times for
the iPhone 11 have been longer than everyone expected!
■ Cyclical Japan, which can be thought of as the industrial
heartbeat of the global economy, seems to have a pulse since
September. (The same cannot still be said for Germany – yet.)
■ And lastly, for all of the UK Parliament’s attempts at reliving
‘groundhog day’ with reference to Brexit, with elections in
December, a no-deal Brexit off the table, it feels like we are
much closer to the resolution of uncertainty within the next
six months – theoretically positive for sentiment both in the
UK and Europe.
■ While this is the tactical set-up which could continue to
lead the market higher, it would require a rotation from
defensives into cyclicals and value versus growth. We have
had a number of false starts to this and all the ducks need
to line up (including the ever-important yield curve!), but it
does feel like, with the round of coordinated global easing
since January 2019, the central banks have succeeded
once again in administering more morphine to the patient
and grabbing a temporary victory from the jaws of certain
However, in spite of all of the above, the structural concerns are
very much alive.
■ Central bank financial terrorism remains alive and well, with
over 25% of government bonds in negative yield territor – this
is clearly where the bubble lies and what is currently playing
havoc with any analyst’s earnings and discounted cash flow
models. (The difference between a 2% risk-free discount rate
and 5% rate for a given stream of cash flows is about 50% on
any stock price.)
■ Given the incentive structure, corporate leverage has
continued to rise even higher, with buybacks (at least in
the US) continuing to fuel the equity markets.
From the desk of Amit Lodha
Fidelity Global Equities Fund
28 October 2019
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■ And while we may get some temporary resolution on the
trade war between China and the US, it is unlikely we are
ever going back to how things were before Donald Trump
started it all!
■ Protests (inequality is increasing/capitalism is not working)
around the world (Chile, London, Barcelona, Argentina,
Lebanon, Hong Kong) are a sure-fire indicator that the
current state of play is not working and needs to change!
Constructing portfolios to out-perform in this environment
becomes ever more complex. Bond-like defensive equities feed
off the circular logic of being cheap ‘relative’ to their negative
yield government bond brethren, yet seem egregiously expensive
on any historical absolute measure in a ‘normal’ world. Quality
at reasonable value is an oxymoron!
On the other hand, cyclical equities seem cheap on current
expected consensus earnings, but it is fair to say that in a deep
recession, they also are about 20–40% over-valued on an absolute
basis to their deepest drawdown price, and every investor needs
to ask the question if he or she will have the emotional ability and
patient capital (no pun intended) to hold them through that period.
The job description of an active equity investor is pretty simple –
develop a view on markets/individual stocks to exploit an
inefficiency, decide how to express that view (which stocks to
buy/sell), and when.
So, here are my views:
■ I am not worried about Brexit. With the elections, I think
over the next year we will see some resolution around Brexit
and, with uncertainty removed, this should augur well for
UK and European equities (markets hate uncertainty more
than anything else). In fact, if we did not have the non-zero
risk of a Labour government, UK domestic stocks would be
the biggest overweight in my portfolio!
■ I think there will be a trade deal. Even if it is not the trade
deal, Trump understands the election maths, especially in the
swing states, and he would like to get re-elected. Watch the
corn belt and the Midwest as these are bearing the brunt of
the industrial recession and need things to turn around for
people to be happy and vote for Trump again! A stimulus
trade deal around agriculture/ethanol policies could all be in
the works by the end of the first quarter.
■ Both of the above should be positive for the cyclical end of
equity markets (value and maybe cyclical value!). However,
duration of ownership of these businesses depends on the
economic cycle and the yield curve, and hence one needs to
exercise great discipline around the valuations paid as well
as not overstay one’s welcome. After all, we are in the tenth
year of this very shallow upcycle!
■ What I am really worried about is ‘democracy’ and
capitalism. As a student of history, it is clear that the world
goes through cycles of wealth accumulation and redistribution,
and it seems to me we are the end of accumulation and
possibly at the start of redistribution. Higher taxes, more
fiscal rather than monetary policy, protectionism and inflation
are legitimate worries for the 2020s. Most of all, being a
global investor, I worry about the risks to globalisation (see
my note of July 2019, ‘Is the end of globalisation the end of
■ The Democratic party platform in the US (Warren/Sanders)
and the Labour platform in the UK both have some form
of ‘socialism/wealth redistribution’ embedded in them.
US markets overall currently reflect a very low probability of
a Warren/Sanders regime. Paradoxically, however, if we enter
a recession (fuelled by low business leader confidence), the
chances of one of these candidates being in the White House
■ Let’s be clear, If there is regime change in politics this
time, that regime change is undoubtedly equity-markets
negative. As we get closer to election season, both in the
UK and the US, I would expect daily gyrations to follow the
polling numbers of the key candidates and to have significant
implications for most equity market sectors (not only for
healthcare/energy, as some market participants would have
■ The above uncertainty and current valuations would suggest
that the US should remain underweight in any global portfolio
as we navigate 2020, given the risk of heightened political
volatility. Technology companies, especially large-cap, will
see risks of increased regulation as well as the likelihood
that the tech world will be increasingly divided into China
and non-China. The law of large numbers also looks like it
is catching up on them. Invest accordingly!
■ Pockets of stability where there is limited risk to current
systems of governance or which can safely work with both
the US and the Chinese systems (what we referenced as
‘Switzerlands’ in my July ‘End of globalisation’ note) may
enjoy premium valuations – seek those out!
■ As ever, companies that are not impacted by significant
government oversight and regulation and which are in
control of their own destiny, run by exceptional managers,
and which are available at reasonable valuations would
be the best place to be in all scenarios: that remains where
we seek to spend most of our time to grow your capital.
Above everything else, be serious about humour – you will need
it to navigate 2020!