Note Oct 15,2020: Q4/2020 – Outlook Paper Thin Not Iron Clad Or Gilt Edged: In the U.S., Japan and Europe exist central bank and political tussles including flux in policy. Solvency and deficits appear getting little attention from many authorities. In finance as in the science of fluid mechanics, the wanton opening of floodgates rather than metered sluice guidance increases risks of harmful eddies. Perspective appears from different vantage classic writings by titans like Benjamin Graham, William Sharpe and Peter Drucker.
Post a bitter November 3, 2020 U.S. election, there lie significant global decisions; not least about fiscal spending for growth and deficits and trade; China appears flexing a more aggressive political posture; the European Union has many internal political, trade and financial stresses.Further, regional hostilities appear rising into outright conflict in many parts of the world. At present, policy efficacy seems paper thin and not iron clad or gilt edged.
The prongs of Covid-19 pandemic and irredentist territorial claims have been sharpening. In the movements of gold, the Swiss Franc, the Renminbi and many G-7 currencies versus the U.S. dollar and notwithstanding relative liquidity, we see ratcheting of tensions and volatility. The currency markets are diverse by participant and at $6.8 trillion in daily trading, not easily tamed. We expect resurgence by participants like hedge funds in strategies such as convertible arbitrage, paired trading and currency arbitrage.
Due to high valuation and solvency risk among other factors, volatility in equities and fixed income is likely to be elevated. Rebalance between valuation and momentum appears overdue. it is likely to include currency volatility. Our earnings expectations are lower and recovery profile longer than consensus appears to espouse. It would mean that the quality of restructuring delivery is crucial as a differentiator.
In fixed income both of the government and private variety, yield compression appears mandated by central banks but solvency is a consideration. Albeit with U.S. dollar denominations dominant, it supports diversification, including Yen denominations and strong emerging economy segments. We espouse short duration in fixed income and precious metals like gold bullion instruments in asset mix.
In emerging equity markets, the advantages likely lie with stronger growth in Asia. Overall, sector leadership likely resides in the United States but we also see opportunities to overweight Japan on restructuring. Smaller companies likely present vulnerabilities worldwide. We favor quality differentiation of the strong balance sheet variety and that related to operating management. It contrasts in markets with wholesale reliance on ETFs that has appeared for a prolonged period amid massive quantitative ease.
With Information Technology weightings on the S&P 500 having reached close to 29% in momentum markets, portfolio diversification and not just index benchmarking appear considerations. In growth, we suggest strong balance sheet Healthcare at overweight, Information Technology at market with Consumer Staples and concept social media at underweight. In cyclicals, rather than an early cycle tradition of overweighting Consumer Discretionary, currently we overweight Industrials related segments and for diversification, we also overweight Materials as well as strong balance sheet, severely out-of-favor Energy. Performance in the Financials sector remains crucial for market direction. We favor banks where less excess may reside as a result of continued, severe restructuring.
Asset Mix
Assurances of efficacy of policy can be paper thin rather than iron clad or git edged. As even a cursory look at the science of fluid mechanics reveals, the wanton opening of floodgates rather than metered sluice guidance increases the risk of harmful eddies forming. We believe the same applies to such allusions in finance. Markets seem overly enamored with central banks being both able and willing to cushion risk. Even a casual perusal of central bank history would cast doubt on assumptions of their (or anyone else’s) clairvoyance. Hence, titans of finance like Benjamin Graham and William Sharpe developed emphasis on risk premiums, albeit from different perspectives. Management gurus like Peter Drucker focused on systematic thinking in managing companies.
In overemphasis on momentum which in recent periods has characterized markets, we believe rebalance of risk premium compression in fixed income and of valuation versus momentum in equities are overdue and being obfuscated. Monetary and fiscal stresses seem more extensive than markets seemed to reflect in their responses to Federal Reserve led largesse. In the movements of gold, the Swiss Franc, the Renminbi and many G-7 currencies versus the U.S. dollar and notwithstanding relative liquidity, we see a significant ratcheting of tension.
In the United States, Japan and Europe exist both central bank and political tussles amid individual hues of domestic political uncertainty as well as flux in policy. From many authorities, solvency and deficits appear getting little attention. Coincidentally but factually so, the prongs of Covid-19 pandemic and irredentist territorial claims have been sharpening onto political tensions this year. Despite the central banks focusing on liquidity, currency volatility is likely to expand,.
Post a bitter November 3, 2020 election in the United States lie postponed but significant decisions globally, not least about fiscal spending for growth and deficits. In Asia, China appears flexing a more aggressive political posture with its neighbors. Japan with a new prime minister may have newer initiatives to continue augmenting regional and global leadership. Trade tensions appear as well with supply chains likely to evolve. For the European Union remaining as sources of stress are social policy like refugee standards and standards of justice as well as fiscal measures including budgets. Between the European Union and the U.K., the handling of backtracking on Brexit agreements once more emerges as stress. Whether long ago in socialist systems like Mr. Stalin in Russia or Mr. Mao in China or democracies like Mrs. Thatcher in Britain or currently such as for Mr. Trump in the United States and Mr. Johnson in Britain, caricatures rise as uncertainties build. Further, regional hostilities appear rising into outright conflict in many parts of the world. Political confidence at present seems paper thin and not iron clad or gilt edged.
The International Monetary Fund in its October 2020 Global Economic Outlook and companion Global Financial Stability reports does point to some improvement since mid-year in global economies. Other comments suggest change from the IMF advice midway in the credit crisis into 2012 of considering as a suitable stable target, fiscal moderation with 60% of debt-to-GDP as stable aspiration. Currently the advanced countries could choose to finance fiscal stimulus by borrowing on public markets with restructuring of public finance now globally at above 100% debt-to-GDP as likely getting emphasis for decline only post 2025. It also points to fiscal risk in weaker economies.
Recent comments by the Federal Reserve have especially emphasized the need for continued stimulus as well as enhanced fiscal measures. Not long ago, the Federal Reserve had no inflation target, then it adopted one and now it has placed major emphasis on moving away from a specific 2% inflation target. Both the European Central Bank (ECB) earlier and the Bank of England more recently appear to be focused on short term liquidity in economies. The Peoples’ Bank of China does appear more sanguine than other major central banks to the point of allowing the Renminbi to rise sharply versus the U.S. dollar. In uncertainty in economies, when revenues turn ephemeral due to business changes or severe competition, solvency guarantees can be paper thin and not iron clad or gilt edged.
Within recent memory amid capital markets that appear obsessed with short term momentum, there have only been few bouts of currency volatility and excepting currencies such as in Latin America and Turkey. It is likely to change. In a period of revenue growth being slow and political turmoil of various stripes being up. Even minor exchange rate changes could be magnified in impact on financial statement translations. Due to their unpredictability, currency effects tend to be of surprise to consensus. Currently it is likely to be especially so, even amongst the largest currencies. It argues in favor of diversification.
For myriad reasons among the largest currencies, the Yen is now close to 105, the Euro pushing up to 1.18, the Renminbi close to 6.7 and the smaller but significant Swiss franc close to 0.91 while sterling to the U.S. dollar waxes and weaves around Brexit risk. The $6.8 trillion in daily currency trading dwarfs annual global GDP of $88 trillion in 2019 and total central bank reserves of around $30 trillion, clearly not all of which are liquid. The currency markets are diverse by participant and not easily tamed. We would expect a resurgence by participants like hedge funds in strategies like convertible arbitrage, paired trading and currency arbitrage.
Due to high valuation and solvency risk among other factors, volatility in equities and fixed income is likely to be elevated. Rebalance between valuation and momentum appears overdue. It is likely to include currency volatility. Our earnings expectations are lower and recovery profile longer than consensus appears to espouse. It would mean that the quality of restructuring delivery is crucial as differentiator.
In terms of growth recovery as in the past and again currently, eastern Europe, Latin America and Africa have appeared especially vulnerable. Future solvency risk could be exacerbated by heavy borrowings already recorded in the current environment. In fixed income both of the government and private variety, yield compression appears mandated by central banks but solvency is a consideration. Albeit with U.S. dollar denominations dominant, it supports diversification such as including Yen denominations and strong emerging economy segments. We espouse short duration in fixed income and precious metals like gold bullion instruments in asset mix.
In emerging equity markets, the advantages likely lie in Asia with stronger growth. Overall, sector leadership is likely to remain with the United States but we also see opportunities to overweight Japan on restructuring. Smaller companies likely present vulnerabilities worldwide. We favor quality differentiation of the strong balance sheet variety and that related to operating management. It contrasts in markets with wholesale reliance on ETFs that has appeared for a prolonged period, amid massive quantitative ease.
Notwithstanding the sharp bounce up in equities from the low index levels of March 2020, we see opportunities to rebalance. With Information Technology weightings on the S&P 500 having reached close to 29% in momentum markets, portfolio diversification and not just index benchmarking have come to be considerations. In growth, we suggest strong balance sheet Healthcare at overweight and Information Technology now market weight with Consumer Staples and concept social media underweight that have led momentum. In cyclicals, rather than an early cycle tradition of overweighting Consumer Discretionary, currently we overweight Industrials related segments, for diversification we have also overweight Materials. Strong balance sheet, severely out-of-favor Energy offers similar opportunity. Performance in the Financials sector remains crucial for market direction. We favor banks where less excess may reside as a result of early and continued restructuring.
Equity Mix
During the reporting of corporate resultsamid global, massive quantitative ease, equities have appeared responding with upward momentum on results being above much revised consensus, even when they have been in decline. There is another, longer term facet to consider, namely that of matching long term growth expectations with deliverability and consequently of valuation. Our earnings expectations are lower and recovery profile longer than consensus appears to espouse. It would mean that the quality of restructuring delivery is crucial as a differentiator. especially given that productivity pressure has continued to afflict the pandemic driven business environment.
A measured and not exuberant earnings recovery profile seems likely.Valuations globally appear to be extended and appear to include expectations of swift earnings recovery followed by above average long term growth. Company commentary worldwide and in diverse industries appears cautious about the time needed for operations to recover fully.As global indicator, the S&P 500 has a long history of around 16x P/E valuation for around 7 % annual earnings growth. Even if earnings have bottomed in Q2/2020, we believe that the recovery of earnings could take three years to reach their pre-2020 levels, such as the 157 level in 2019 for operating earnings for the S&P 500.
We assess that at around 30x earnings, a long term earnings delivery of 15% per year would be incorporated. Even on 2019 operating earnings of 157 as base, stability would likely need aggregate market earnings delivery of the much espoused but never achieved consensus expectation of sustained long term annual earnings growth of 12%. Individual and not necessarily unseasoned concept equities at over 50x P/E multiples would appear to have incorporated long term annual earnings growth expectations closer to 20%. Rebalance between valuation and momentum appears overdue. It is likely to include currency volatility. During momentum and quantitative ease obsessed markets, it seems de riguer for three quarters of companies to be recording as beating but oft revised consensus. Still, a test lies within the Q3/2020 results being released. The potential for volatility remains high.
Notwithstanding the sharp bounce up in equities from the low index levels of March 2020, we see opportunities for investment portfolio rebalance. With Information Technology weightings on the S&P 500 having reached close to 29% in momentum markets, portfolio diversification and not just index benchmarking appear as appropriate considerations. In growth, we suggest strong balance sheet Healthcare at overweight and Information Technology market weight with Consumer Staples and concept social media underweight that have led momentum. In cyclicals, we favor Industrials related segments over Consumer Discretionary that was so favored in the last cycle for aspirational spending built upon leverage. For diversification amid trade and recovery tensions, and unlike a traditional cycle in which it is considered to be late cycle, we have also overweight Materials. Strong balance sheet Energy offers similar opportunity and additionally has been severely out-of-favor. Performance in the Financials sector has been and remains crucial for market direction. We favor banks where less excess may reside as a result of early and continued restructuring.
Communication Services: Over two decades, Communications Services has experienced the vulnerabilities of weak balance sheets and of tentative, over expansionary business plans It resulted in the bankruptcy of many telecommunications businesses and restructuring of others, large and small. High valuations were in retrospect conflated with the ability to deliver elevated growth. Currently, another segment of Communications Services, namely social media has similar challenges of delivery versus valuation. Starting in Europe and now expanding globally, there appears expansion in political intervention into social media to push it from being managed as a simple conduit and into being a business that has societal stakeholder responsibilities for accuracy. It seems an evolution akin to that of say newspapers from infancy into today. We are overweight Communications Services but favor telecommunications for both financial strength and regulatory expertise.
Consumer Discretionary: In myriad consumer cycles in the past while bottoming out, U.S consumers have tended to lead. In purchasing power parity terms at least equal and likely larger still have been consumers in China in this cycle. Dominating globally over impulse aspirational purchases such as fashion appear to be purchases of basic items as well as do-it-yourself (DIY) splurges on old fashioned cocooning improvements in homes. Online shopping appears gaining strength. Those catering to the classic requirements of the wealthy upper crust appear to have done better in luxury than those banking on aspirational forays. Aspirational forays started as long ago as the early 1990s amid higher leverage in advanced economies and the opening up of previously controlled economies. Much has changed now. Amid social distancing, layoffs and the ongoing Covid-19 pandemic, myriad aspects appear. We envisage the critical consumer sector as still being in restructuring. Solvency stress appears with especial risk in brick and mortar fashion. We have underweight Consumer Discretionary but would favor DIY and online basics purveyors within the sector.
Consumer Staples: High valuation and even within the same company a proliferation of competing brands likely afflicted the Consumer Staples sector compared to yield and defensive alternates in Communications Services and Healthcare. Both the latter appear arguably at a more advanced stage of business restructuring. We note shelf space challenges in Consumer Staples as existent across many geographies and as well as in myriad segments. Even well regarded restrained segments such as both the soft and liquor drinks businesses appear to have even afflicted. Once regarded as prima facie go to market defensive investments, the drinks segments are again restructuring. We have underweight Consumer Staples.
Energy: Weak oil energy demand has been driven by a slowdown and alternate energy expansion, including natural gas. It was exacerbated by the ongoing Covid-19 pandemic as well as by OPEC and non-OPEC hydrocarbons, including shale oil, being overproduced. Turmoil was augmented by a number of political tensions. They range from the United States and Iran over nuclear matters, to field delineation in new discoveries around the Mediterranean to wars over borders in the Caspian Sea region raising reliability concerns. There are also uncertainties between Russia and the European Union over the reliability of the Nord Stream gas project. Since their inception, Energy companies have had to deal with politics as well as with product supply and demand. The International Energy Agency projections suggest demand recovery towards 100 million barrels per day in 2021, driven by Asia. Hydrocarbons are unlikely to disappear as a crucial source of supply of raw materials from transportation to pharmaceuticals and in between. Crude oil prices dropped to $25/Bbl. WTI and currently stride $41/Bbl. WTI. Our expectation is of the stable zone for crude oil being around $60/Bbl. WTI. Posthaste environmentally sustainable growth ( ESG) strictures injected into investment portfolio mandates have further afflicted hydrocarbons portfolio investments. Overleveraged companies are likely to disappear or be subsumed. Energy sector weights have dropped to minimal levels. It offers opportunity to overweight the strongly financed and business risk managed diversified integrated companies.
Financials: Restructuring requirements continue in the Financials sector which is crucial both for capital markets direction as well as fundamentally for economies at large. In the reality of capital markets being consumed by fervor for momentum in performance and largesse from central banks, the Financials sector seems performing only in afterthought. Challenges do exist such as tardy restructuring in Europe and leveraged credit excess in Asia and Latin America. Net interest margins do face pressures from central bank policy led by the Federal Reserve and the European Central Bank. Amid a global slowdown, the quality of borrowing clients and indeed that of sovereign countries as a whole appear as risks for the Financials. Top quality clients are likely to be sticky in favoring existing relationships rather than welcoming alternate overtures. As well, strong investment banking and trading revenues appear accruing to the same. Rather than avoiding it, we see challenges as reasons to overweight focus in Financials on those strongest and earliest in business restructuring. It contrasts with the market penchant generally for solace from central bank largesse and for low quality.
Healthcare: In the absence of a robust cure, the millions of cases worldwide in the Covid-19 pandemic across the world and hundreds of thousands of deaths represent nothing less than a crisis of unknown duration. As a new and avoidable challenge, a second wave has appeared amid a sense of lax across demographic and income cohorts. As such, pharmaceutical and biotechnology companies have both been engaged in discovery and testing intrinsically as well as via acquisitions of licenses and whole operations. Protective Protection Equipment (PPEs) remains both urgent and in short supply. Stepping up have been both existing and emerging medical device suppliers. Healthcare facilities purveyors such as hospitals are being forced as are their funders, governmental and private, to restructure priorities. Budgets are likely to rise and practices sharpened. We believe these realities are conducive for an overweight in Healthcare across its segments.
Industrials: Apart from Covid-19 pandemic induced shutdowns, low productivity has been existent for many years. It has not been a new phenomenon, not least during these prolonged times of quantitative ease. Simply put, instead of upgrading infrastructure over the years, public finance budgeting has instead tended to leverage upwards social spending. In corporate capital allocation during a momentum oriented capital market, increasing leverage and buying back of equity took place rather than investment in training, upgrading and diversifying of facilities to boost competitiveness. Now and not least for reasons of survival, we expect institutional priorities to to have to lurch towards capital investment and training. Likely to be emulated would be German Mittelstand manufacturing and product system of flexibility. In it continuous long term revenue improvement delivery has long dominated simple cost considerations. Public infrastructure spending can lso be expected from governments. Among the cyclicals , we stress these aspects to be favoring an overweight in Industrials in contrast to our underweight in consumer areas.
Information Technology: After its 1999/2000 debacles with concept euphoria, Information Technology has lately had its attractions due to business restructuring and the growth prospects emanating from still evolving business growth linked to social media. It includes building 5G networks, cloud computing and remote connecting, all likely to expand beyond the emergencies of the Covid-10 pandemic. In a momentum driven market more lately, even for those companies with strong balance sheets and solid products/services, consensus assumptions appear incorporating long term earnings growth of 20% annually, a feat previously unmatched for statistical and competitive reasons. At a weighting close to 29% for Information Technology in the S&P 500, fiduciary as well as diversification considerations also loom for investment managers. Momentum fervor notwithstanding, we would choose to be capped at neutral while still selectively favoring companies with robust balance sheet and business lines.
Materials: For several reasons, currency volatility has the potential to spread from a relative small coterie of emerging market currencies. It is likely into even advanced country currencies that have appeared becalmed amid massive quantitative ease. Such currency volatility risks would likely be linked to Covid-19 pandemic effects on activity; to laxity on deficit control when economic growth was stronger and to concern about the efficacy and distortions inherent in chronic quantitative ease. There is as well flaring of political tensions from the Caspian to the Mediterranean to the Arctic to the Himalayas. In other areas of materials, relative buoyancy of housing and trade tiffs have increased demand for lumber and base metals. Rather than being a classical late play on cyclical bottoming, deep restructuring in base metals has appeared to make its segments an early play. We have precious metals as overweight for asset diversification and base metals as cyclical over weights alongside Industrials related segments with consumer related areas at under weight.
REITs: Urgency in the repurposing of retail center space and commercial space likely has as much to do with health pandemic concerns as it does with changes in the modalities of behavior. Newer technologies have simply changed expectations about real estate usage. While rental properties have appeared to be a refuge in the residential space, it has also been particularly so during a period of governmental emergency income supplements for those hardest hit. Affordability of housing remains a concern for many in the millennium cohort with a resultant of reacceptance of the age old reality of multigenerational sharing of space. Seemingly less affected but nonetheless challenged has been industrial space. Infrastructure upgrades by corporations and governments worldwide are both likely and urgent. Despite low interest rates being seen as a panacea, we have underweight REITs and real estate as we balancelow administered rates against the likelihood of restructuring due to obsolescence being prolonged in many personal and business facilities. As such, we favor industrials related segments within the real estate space.
Utilities: Traditionally, Utilities have been considered to be defensives due to regulatory balance in the form of mandated rates of return on capital as well as due to dividend yield comparisons with interest rates and fixed income yields, many currently suppressed. Still, Utilities have business challenges. Slower economic growth has had cyclical impact on demand for utilities such as electricity. Meanwhile, Utility plant facilities investment have to be mainly upfront and not built piecemeal other than for rejuvenation and additions to complement facilities. Not surprisingly, long standing concerns have developed over nuclear facility construction as well as more recently over pipelines and terminal facilities on ESG concerns. Climate change and green policy adherence expectations add to pressures for new facilities while mothballing others such as in coal driven electricity generation. Potential exists for stricter regulations for water delivery facilities. With performance already accrued on the stretch for yield, we have underweight Utilities. Their defensive reputation may be compromised were fixed income markets turn volatile. We suggest diversification within Utilities.
Asset Mix
Global U.S.
Equities-cash 52% 57%
-priv. 6 6
Fixed Income 25 20
Cash 12 12
Other 5 5
Total-% 100 100
Geographic Mix
Currency/ Equities Fixed Cash
Real Income
Americas 61% 65% 67% 55%
Europe 22 20 26 37
Asia 9 13 6 3
Other 8 2 1 5
Total -% 100 100 100 100
Global U.S. Stance
Comm. Serv. 6.0 % 12.0 % Over-weight telco, under social
Cons. Disc. 4.0 5.5 Under-weight favor basic online
Cons. Stapl. 4.0 3.0 Under-weight still brand pruning
Energy 6.0 4.0 Over-weight favor strong cos..
Financials 19.0 13.5 Over-weight restructuring
Healthcare 16.0 20.0 Over-weight critical delivery
Industrials 13.0 9.0 Over-weight on capex gain
Info. Tech. 20.0 25.0 Market-weight diversify
Materials 8.0 4.0 Over-weight precious metal.
REITS 2.0 2.0Under-weight retail & office
Utilities 2.0 2.0 Under-weight – diversify.
Total-% 100.0 100.0 () prior weight 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.
Note Précis Nov 18,2020: Old is New – Coordination Not Confrontation:
Note Précis Oct 15,2020: Q4/2020 – Outlook Paper Thin Not Iron Clad Or Gilt Edged:
Note Précis Sept. 18, 2020: New Is Old, Again – Currency on Watch
Note Précis September 4, 2020: Market Momentum Meets Messaging Mash
Note Précis July 24,2020: Q3/2020 – Wishful Denial a Risk