The Days Ahead: Busy economic numbers but no corporate updates
One-Minute Summary: Anyone hoping for a quiet week was disappointed. The market suffered a 3.5% two-day loss before recovering on Wednesday. For most investors, this year has not left much to be thankful for. Nearly all asset classes we know have weakened: gold, commodities, large cap, international, emerging, credit and even Treasuries. The S&P 500 is up for the year but by the thinnest of margins. There were no new problems last week nor were there any resolutions to the problems. We'll restate these because they're important and none really lend themselves to quick fixes:
China trade: all eyes on the G20. So far, no breakthrough
Peak earnings: companies may face higher wage bills or just decide not to expand
Economic slowdown: this week it was lower industrial production and soft, but not deteriorating, numbers in housing.
Fed rate hikes: no hint that the Fed is concerned about the weaker economy and will let up on rates
This week also saw another indicator that the Kabuki theatricals on trade are hitting home. Here’s a story about farm produce rotting because of collapsing Chinese demand. And here’s a chart showing declining Chinese import of manufacturing components and the decline of U.S. durable goods orders. We advanced the China data by three months so it’s clear what’s going to happen to U.S. orders in the next few months:
Markets settled on Wednesday. Volumes were low and Treasuries moved less than 2bps.
Tech takes a hit. We've been nervous about the FAANG trade for a while. For those not familiar, this was the name given to Facebook, Alphabet-Google, Amazon and Netflix, which had a phenomenal run in 2017 and most of 2018. Other companies came along for the ride, including Microsoft, Nvidia, Tesla and Alibaba. Together they became the driver for much of the S&P 500 in 2018 and were around 18% of market capitalization at the September peak. They're now 14% and the S&P 500 is 9% lower. What happened?
Valuations: most of the big tech stocks traded on premium multiples and were around 40% more expensive than the market average. At those levels, they're priced to perfection. Every earnings call must beat estimates with bullish outlooks for sales and costs. One slip and the momentum investors bail.
Regulatory: most of the tech companies live under a very benign regulatory environment. U.S. competition policy is hopelessly outdated and unless there is a price impact to consumers, they're left well alone. EU takes a different approach and looks at privacy usage, bundling and threats to new entrants. The EU has taxed, fined and warned many of the tech companies for some years now. The U.S. may now follow suit.
Management: Facebook’s cavalier attitude to privacy and trolling is beginning to irritate politicians and the public.
Sector realignment: we discussed here about the new S&P 500 sectors, which moved companies to and from tech and into the new Communication Services sector. It’s all a little opaque but we’re pretty sure the rebalancing has not finished.
The news from Apple fits the above but the main story was about “peak iPhone”. The company has made much out of its ability to command a price premium. The new iPhone X started out well but Apple sources 18% of its revenues from China and there are indications of some pushback from customers. Apple revised its volume estimates and its suppliers were hit badly. Here's an ugly stock chart of some of those suppliers over the last three months:
We expect Apple to recover. It’s fast becoming cheaper and it has a fortress balance sheet. Its glory days may have peaked but as many investors learned to their cost, it’s not a company to underestimate.
Bottom Line. We think most of what has happened is a healthy correction, although on any one day it sure as heck doesn't feel like that. There is some speculative blow off (tech), some genuine geo-political concerns, and some reevaluation of stocks. We don't see big leverage causing a problem, aside from stuff like leveraged loans but that’s a market unto itself. Nor do we see unfathomed optimism, although, again bitcoin has certainly trapped the unwary. For now, we’re defensive.
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