Note Dec. 11,2020 – Narrow Path To Hew

Note  Dec. 11,2020 –  Narrow Path To Hew: There appears a narrow path to hew whether considering politics, economics and capital markets valuation. Meanwhile, momentum and central bank largesse driven complacency in markets risks enhancing volatility.

On politics and trade, long dated frictions appear from resources to aircraft to info. tech. to services. Tariffs and trade have long    motivated successive U.S. administrations of either party. The full spectrum of U.S. policy is likely to be unveiled over months and not weeks. Elsewhere, long term fissures in Europe are exposed from the west in Brexit talks and within the east in vehemence in Poland and Hungary. German populace patience may be stressed on being taken for granted. In Asia as exposed on social political and economic matters, China appears prepared to risk prolonged blowback, likely from near and far. The Levant endures an explosive cauldron. Seemingly latent, political stress is likely.

Irrespective of Covid-19 vaccination schedules, economic recovery is likely to be globally gradual. Arithmetically, global economies would be weaker than before even if 4 ½% GDP recovery in 2021 were to follow contraction in 2020 of 4 ½%. Unlike pre-2000 mainly U.S. consumer centric cycles,  the current mix realities reside in three power blocs of Asia, Europe and the United States. Also, many prior cycles have had as stimulant, massive early consumer aspiration. Currently, we expect the early stimulant to recovery to be smaller and likely to require broad based infrastructure and physical investment activity.

Of interest in capital markets are currency signals; yield compression in fixed income; and valuation sustainability in equities –  all relative to achievable long term growth. The U.S. dollar has had significant recent weakening amid fixed income yield bifurcation. Such fissures in 1987 were precursor to stress. U.S. corporate yields have compressed versus longer term Treasuries which in turn appear to be moving in different swirls than German bund yields. Meanwhile, European government yields spreads seem compressing. The narrowing Netherlands versus Germany spreads may signal stress.

Long cycles tend to dull institutional memory. Portfolio diversification remains in order. By espousing short duration during potential currency market volatility, we underweight fixed income with overweight in precious metals.

Notwithstanding monetary ease, internal sector momentum mix and valuation versus sustained earnings deliverability are likely to be equity issues. By contrast, momentum activity and even theoreticians has appeared driven by equity premiums versus ambient bond yields. The momentum cycle has been low quality and social media centric. Our focus is on sector rotation evolving and on best of class quality. For an infrastructure and physical investment driven period, we favor industrials, financials, resources, structural information technology and healthcare over the social media and consumer areas.

Seasons Greetings and be Safe.

In politics and trade, long dated frictions appear from resources to aircraft to info. tech. to services. Instead of being rigorously defined with respect to efficiency, level playing field exhortations have long had a political and emotive dimension that often play to domestic pressure points. During slower growth, such domestic exhortations tend to become shriller.In politics, the U.S. presidential election took place over a month ago. Protestations about state short comings appear to have been futile. U.S. President-elect cabinet appointment proposals are being rolled out. Given the urgencies of Covid-19 pandemic, the proposals started with those in economics and in health. The full spectrum of U.S. policy are likely to only start being unveiled over months and not weeks. The incoming U.S. administration can be expected to have domestic pressures. Also of import is that when it comes to tariffs and trade and even if not as overtly as during 2016-2020, successive U.S. administrations of either party have been motivated to use them. Furthermore, deficits and fiscal control are likely to be issues that cannot not easily wished away.

Elsewhere, long term fissures in politics in Europe are persistent. They are likely to continue from in the west as exposed in the mere dragging out of Brexit talks over standards as well as agricultural/fishery policies. In the east and despite being major funding beneficiaries since joining the European Union, there is the vehemence of Poland and Hungary about enhancing civil liberty restrictions.  These facets are of concern about disruption of EU budgeting and cohesion. Practically since inception of the European Union and its predecessors since the 1950s, Germany has had a key role as backstop for Europe, not least in financial transfers. Prolonged minimalist interest rates have especially affected German savers. German populace patience may fracture on being taken for granted for so long. Such resistance is already evident in the frugal four of Austria, Denmark, the Netherlands and Sweden.

In Asia, the assertiveness of China extends to being prepared to risk blowback in social, political and economic matters, not least from its neighbors near and far. Seen initially in the south China seas over maritime borders, it now seems extended to countries like Australia and Canada with whom no border concerns exist. Concern about such stresses can be seen in the key global growth balancing areas of southeast Asia and India as well as in advanced economy Australia and Japan. The TPP and RCEP trade agreements are positive but nonetheless seem likely to face trade friction pressures. The Levant endures as an explosive cauldron. Seemingly latent, political stress is likely.

Irrespective of the rollout schedules for Covid-19 vaccination over 2021 and beyond, economic recovery is likely to be globally gradual. In December 2020,  the OECD unveiled its quarterly global assessment. The Bank of International Settlements in its quarterly also commented on global capital market and central bank policy matters. Arithmetically, global economies would still be weaker than before even if 4 ½% global GDP recovery in 2021 were to follow contraction in 2020 of 4 ½%. Much momentum activity in markets appears still to depend on central bank largesse. In terms of perspective, the Bank of Japan possesses the longest history of quantitative ease. As demonstrated in Japan since 1990, growth has many tangents that are separate from monetary largesse and minimalist administered rates.  The size of deficits and of debt levels are of concern as potential sources of bifurcation and fissure in capital markets. It has been already the case in several emerging economies and industries. The path to recovery to hew may be narrow, much more so than markets appear to recognize.

Equally, pre-2000 cycles were mainly U.S. centric in that countries secured growth by exports to it and specifically to satisfy U.S. consumer demand growth. Current realities have evolved into now comprising three economic power blocs of Asia, Europe and the United States. Many consecutive cycles have been stimulated in their early stages by consumer aspiration mainly from the United States followed by other advanced countries and not least in the last two decades, by aspirational emerging economy consumers. Personal debt levels and employment uncertainty could tame such early activity.

Compared to a massive consumer cycle of the types experienced in the past, the current early stimulant will likely be smaller in being infrastructure and physical investment driven by both countries and companies. The logistical weaknesses of global production and delivery were being exposed even before the Covid-19 pandemic and have been exacerbated by it. In many countries, more measured global growth likely adds to internal pressures that were already intensifying due to technology changes. Internal corporate weaknesses similarly likely need facility management changes. Share buybacks seem to us to have had their peak levels of activity.

Of interest in capital markets are evolving currency signals, yield compression in fixed income and valuation sustainability in equities – all compared to achievable long term growth. The U.S. dollar has recently had significant recent weakening. Bifurcation in fixed income appears taking place. Such turmoil in 1987 was precursor to stress. U.S. corporate yields appear compressing versus longer term Treasuries with seeming less regard for credit quality. U.S. Treasury and German bund yields appear moving in different swirls. Meanwhile, European government yields spreads seem compressing. Even prior to inception of the Euro, we have watched fixed income spreads between the Netherlands and Germany. They may again now signal stress. Despite central bank pronouncements about administered rates being kept low for long and replete with gushes of quantitative liquidity, no single policy can be omnipotent. Current fixed income fissures bear monitoring.

For arguably a decade and more, momentum activity in capital markets and even from theoreticians has appeared to be driven by equity premiums versus ambient bond yields. However in business and even as seen in this cycle, capital budgeting and corporate decision making appears to have many more facets than just minimalist administered rates. Over time, competitive opportunities and technological changes have appeared as being some crucial drivers.  At present and in addition to successive announcements of quantitative ease type central bank interventions, aspects of concept and of social media have appeared to accentuate both momentum and leverage response in equity markets.

Loss of institutional memory in a long cycle risks enhancing volatility as seen in many prior cycles, albeit involving different generations and different sectors. By espousing short duration during a potential period of currency market volatility, we balance an underweight in fixed income with overweight in precious metals. Portfolio diversification remains in order.

Notwithstanding monetary ease, internal sector momentum mix and valuation versus sustained earnings deliverability are likely to be equity issues. Even in recovery from the earnings lows of 2009, our expectations have been lower than consensus which more often than not has been lowered. In momentum markets, earnings valuation seem elevated. The momentum cycle currently existent has favored low quality and been social media centric.

Our focus looking forward is on sector rotation evolving and on best of class quality. For an infrastructure and physical investment driven period, we favor industrials, financials, resources, structural information technology and not least healthcare over the social media and consumer areas. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e