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Weekly – Investment Adviser– 19 November

PERFORMANCES 2019

EquitiesBonds
MSCI World+20.8%CHF Corp+2.7%
S&P 500+24.0%US Govt+8.0%
Stoxx 600+19.0%US Corp+13.9%
Nikkeï+15.1%US HY+11.6%
SPI+27.0%EUR Gvt+8.7%
Chine+29.2%EUR Corp+7.7%
Emerging+8.9%EUR HY+7.8%
CurrenciesCommodities
USD index+1.7%Gold+14.6%
EURUSD-3.3%Silver+10.4%
EURCHF-2.4%Brent+16.2%
USDCHF+1.0%CRB index+5.3%
USDJPY-1.0%
EM FX-3.4%

Non-linearity

The relation between economic and markets spheres is complex. This is because human nature and psychology play an important role in setting it up. In simplified terms, we can distinguish between periods of relative alignment – say quadrants I and III – and periods of transition / disconnect – say quadrant II and IV. Periods of alignment tend to last longer, allowing for solid trends to develop. Periods of disconnect tend to be shorter and more erratic – i.e. trend-less -.

 - 19.11.19en - iNVESTOR MATRIX

In Q3 2019, markets have been wary of the ongoing macro deterioration, featuring risks of a recession. Then, the psychology u-turned, following liquidity injections by central banks and a few ¨green shoots¨ – essentially from the soft economic data (leading indicators and ISM surveys). Risky assets rebound-ed, featuring namely the most cyclical (economic sensitive) sectors, like banks and industrials. Interestingly, the (strong) markets’ rebound does not coincide with a proportional improvement of fundamen-tals. For sure, lots of nimble institutional investors are betting on a remake of 2017-2018, whereby a recovery is in the making for 2020, hence a tentative shift towards the quarter IV framework. This current transition should soon end-up with a binary outcome: either the recovery is indeed confirmed (quadrant IV), or a dramatic fall back into quadrant I would ensue…

 

What’s discounted in the – current – prices?

Probably quite a lot… Indeed, the latest fund managers’ survey confirm that a significant portion of professionals have, over past weeks, reinvested their – important – non-working cash into equities. The mechanics of sector rotation – with the outperformance of value / small caps – prefigures a successful reflation.

Sophisticated investors like CTAs and hedge funds have amplified this latest move. The very popular strategies of volatility selling have resurrected, despite the 2 to 3 serious accidents of the last couple of years (VIX-mageddon).

EN - CBOE VIX Futures et non-commercial positions - 26.11.19

Companies results in Q3 didn’t collapse. A negative shock like 2018 will probably not happen, that’s good news. But the consensus for 2020 earnings growth – high single digit – remains probably over ambitious. Especially if the pace of economic activity does not recover significantly.

Certain segments of the capital markets (in the High Yield / leveraged loans) remain under strains. Commodi-ties have not rebounded just like they should if growth picks up. Long-term rates – like the US 10y Treasury benchmark remain in cautious mode…

The buoyancy of equity markets is based on high expectations

It is (not yet) corroborated by other assets

  • The significant rise of equity markets prefigures a soft landing (no-recession) similar to the 2017-18 episode
  • The FOMO (fear of missing out) syndrome is back in force
  • Risks are growing that the current complacency / speculation of investors ends up (again) in a burst of volatility
  • Tactically, we have increased equities, but keeping underweight

 

Currencies. Still value amongst EM currencies

Russian budget spending materially accelerated in October; the government is fulfilling its annual spending plan. The data for the first 10 months of 2019 points towards a material acceleration in the federal spending growth from 5% in September to 22% in October. The key contributors are infrastructure and direct spending. This acceleration is positive news for corporate activity. This may reduce the urgency for the Central Bank of Russia (CBR) to cut rates. It may take time to assess the inflation-ary effect of the budget spending. According to the Finance Ministry (FinMin), each RUB0.1-0.15 trn of underspending has a 0.05-0.1 percentage point (pp) negative effect on inflation. This means that the recent reversal will have a positive contribution on the mid-term inflation trend.

Furthermore, the FinMin just announced that it plans to lower the share of USD in its international savings over 2020. The targeted level has not been explicitly disclosed. Russia is joining the de-dollarization trend. Over the past 6 years, the Russian government USD share has remained stable at around 40%. It lagged the CBR 20pp USD exposure cut, and 10pp commercial banks reduction.

Since August 2019 and the ban on US entities participation into new USD-denominated Russian government bonds, it makes less sense to maintain such a high level. It could reduce its USD holdings to make it more aligned with the international reserves of the CBR around 24%.

EN - RUB vs EM currency basket - 26.11.19

In order to fulfill the budget rule, the FinMin does currency transactions only with the CBR. The FinMin will cease purchasing USD, EUR, and GBP from the CBR. According to CBR data for 1H19, 83% of the local FX market volume is in USD and 17% in EUR. That mirrors the trade flows, which despite the de-dollarization progress, are still USD-heavy.

  • De-dollarization is underway
  • The RUB remains an attractive bet amongst EM assets
  • We still favor emerging bonds in hard currency

 

Equities. Second setback for Amazon

First setback. The US Department of Defense has awarded a giant data storage (cloud) contract to Microsoft for $ 10 billion over a 10-year period. Amazon was on the line. The Pentagon has decided to assign it to a single provider. Google had withdrawn in 2018, fearing that its work on artificial intelligence would be used to make weapons. Amazon retaliates, considering that its AWS cloud activity is larger than Microsoft (Azure), with little chance of success.

Second setback. Nike will stop selling its products on Amazon. The CEO of Nike believes that the right strategy is direct-to-consumer and no longer going through platforms. On platforms, brands are not protected enough and lose control of their image. For Nike, direct online sales to the consumer account for 30% of total sales. Strong brands realize that the traffic generated by their site (for example, NIKE.com) is self-sufficient, more profitable and actually enhances the brand, while the traffic and additional revenue generated by Amazon.com are less profitable and less favorable for the image of brands. Amazon holds 40% of the e-commerce market in the United States, but only 4% of total retail sales.

Walmart and Amazon are competing hard in e-commerce. Walmart posted better-than-expected results with a 41% increase in online sales in 3Q19. Walmart is gaining market share. But the 2 stocks are generously valued: 23x 2019 for Walmart and 55x for Amazon. Conversely, Target (comparable to Walmart in terms of profile) has an attractive PE ratio of 17x, despite a rise in share price of 71% in 2019; Walmart’s share price increased by 27% and Amazon’s share price increased by 16% in 2019.

Walmart and Target have increased their offering in online sales, accelerated delivery services and increased the number of merchandise withdrawal points. Both groups have also benefited from bankruptcies in retail such as Toys R US toys specialist.

As we approach Black Friday on November 29th, Cyber Monday on December 2nd and Christmas sales, we favor Target and Walmart over Amazon.

  • We prefer Target (target price at $ 135), then Walmart ($ 125), then Amazon

 

Equities. The beginning of the war in TV streaming

Disney has surprised analysts with a very good launch of Disney+, its new streaming TV. Disney+ comes with its powerful Marvel, Star Wars and Pixar franchises. Netflix will lose The Office with the arrival of Peacock (NBC Universal’s TV streaming) and Friends with the arrival of HBO Max (AT&T’s TV streaming). The loss of licenses from Disney, AT&T and Comcast will have a huge impact on Netflix. Not to mention the upcoming arrivals of Amazon with the project of Lord of the Rings and Apple TV+ with Masters of the Air, a series produced by Steven Spielberg. Netflix will have to produce content to replace what it will lose, but that will have a cost ($ 15 billion in 2019). The group will only be able to rely on its original content while controlling its costs.

Additional pressure for Netflix could come from an activist / investor in his capital. The analyst who discovered that Carl Icahn and Warren Buffet were investing in HP and Occidental Petroleum respectively, says a major investor would be interested in Netflix.

  • Rising TV streaming offer will slow subscriber growth at Netflix, first in the US, then internationally
  • In a stock market that peaks, we prefer a strong and defensive value like Disney (valuation at $ 165 per share)

 

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