Note May 9,2018: Multipolar Jolt and Grind Markets – Since early 2018, investments have likely entered into multipolar jolt and grind capital market performance. As such, they have likely evolved from a decade long tryst with massive quantitative ease as dominant interlocutor. In fact in Zurich on May 8, 2018, the Federal Reserve Chairman made reference to friction, the evolving global economy and monetary influences therein. In addition to covenant light issuance amid low fixed income yields, an additional anomaly exists of CCC corporate bond yields being sticky close to 12 month low levels while other fixed income yields both rise and are volatile. The market mechanism within fixed income likely needs risk premium enhancement. Not singularly so in Latin America, Argentina and Venezuela illustrate risks as rising of concept investing, even if not as widespread as in the early 1990s. More focus is overdue in fixed income on credit quality and generating free cash flow rather than the erstwhile focus on coupon spreads over sovereign benchmark yields like U.S. Treasuries or German bunds.
In equities, after the deluge from the United States, the sluice of European based corporate results will soon start to flow. Urgent appear revisions for the early leaders in hitherto profitable logistical positioning of the early 2000s. Some express surprise over the paucity of positive equity response to strong earnings growth. The reality seems that the practically unipolar mechanism that so favored momentum has already shifted, amid elevated S&P 500 P/E multiples, year-over-year earnings momentum likely to slow and other uncertainties, not least energy costs.
We are overweight Energy as noted in our Quarterly Asset Mix Note of April 21,2018 titled: Q2/2018 – Markets, Algorithms and the Political Economy. Notwithstanding the hoopla, wholesale hydrocarbon displacements seem not imminent. They are crucial for energy and for goods from pharmaceuticals to information technology to kitchen items. Their production from say biomaterials has a likely two decades long evolution. Oil has long has been a political commodity from its discovery in Petrolia to expansion into Texas/Oklahoma , the Middle East, the North Sea, frontier regions and most lately in shale oil. It becomes more so now as Iran, Iraq, Venezuela pressures reemerge and Russia flexes. The same can be said for natural gas being widely transportable, only comparatively recently. Since 1973 and increasingly so in recent years, a strong market component has added onto crude oil politics. We have assigned a trading band of $60-70/Bbl. WTI in a likely volatile balance between production excess containment against rising demand.
A multipolar jolt and grind market environment appears in place. Rather than pullbacks being dismissed as temper tantrums as in 2013, they presage quality of delivery and of financial strength imperatives. Investment advantages likely also lie with strongly financed, severely restructured energy companies – dovetailing into our portfolio strategy favor for restructuring, quality and value.
We assess that since early 2018, the investment environment has entered into one conducive of multipolar jolt and grind capital market performance. The intersecting uncertainties giving rise to this environment range from politics to trade to energy costs to free cash flow for companies and countries alike. Instead, many have appeared used until now to low interest rates and ample quantitative ease as well as relatively docile major currency exchange rates. As such, investments have likely evolved from comfort from a decade long tryst with massive quantitative ease as the dominant interlocutor and into a more volatile period. In fact in Zurich on May 8, 2018, the Federal Reserve Chairman made reference to friction, the evolving global economy and monetary influences therein (https://www.federalreserve.gov/newsevents/speech/powell20180508a.htm) ranged from differences in advanced country fixed income yields, from exchange rates and the yin and yang of capital flows including into emerging markets.
While capital market were comforted at first from 2009 and then subsequently became comfortable as global growth rates improved and broadened from 2013 especially, they also became reliant on quantitative ease as prime indicator. The so-called temper tantrum of 2013 over policy underscored such dependence. We believe imbalances have now also expanded due to complacency. At the high levels of fiscal and monetary policy, such imbalances could extenuate stress for companies and countries alike as the prolonged acute quantitative ease and manipulation of administered rates is being cut back. Reduction in quantitative ease and increases in administered rates is occurring already in the United States and likely will be so by others over time. In the markets themselves, in addition to covenant light issuance amid low fixed income yields, we see an additional anomaly in CCC corporate bond yields being sticky close to 12 month low levels while other fixed income yields both rise and are volatile. The market mechanisms within fixed income once more likely require risk premium enhancement. More evidence of such risk premium increase assessments appears in the barometer of more volatile emerging country bonds that are denominated in foreign currencies like the popular U.S. dollar, now rising. Not singularly so in Latin America, Argentina and Venezuela illustrate the risks as rising once more of concept investing, even if not to the levels of the early 1990s. We believe more investment focus is needed on credit assessments such as the corporate and country ability to generate free cash flow rather than the erstwhile focus in fixed income on coupon spreads over sovereign benchmark yields like U.S. Treasuries or German bunds.
In equities, after the corporate reporting deluge from the United States, the sluice of European based corporate results will soon start to flow. Already, companies there are pointing to the need to revise the business logistical positioning that was so profitable for the early leaders of the early 2000s. The continued wrangle over NAFTA in North America, the heightened demands of the U.S. trade mission conveyed to China while in Beijing and the European/U.S. parrying over tariffs add up to new uncertainties for business. Currency volatility has been and seems currently still muted among the major portions. As monetary and political conditions change, it is normal for currency volatility to rise and is likely to do so now. It would give rise to more stumbles in result delivery. While there has been surprise expressed in some quarters over the lack of positive response to strong corporate earnings growth but individual strongly negative response to shortfalls in the United States, we see the equity reality as being one of elevated P/E multiples being in place for the S&P 500 while year-over-year earnings momentum is likely to slow in upcoming quarters. In addition to political and trade challenges, energy costs need to be considered in business planning. Not least, the practically unipolar mechanism that so favored momentum has already shifted for the capital markets
We are overweight Energy as elaborated upon in our sector comment in our Quarterly Asset Mix Note of April 21,2018 titled: Q2/2018 – Markets, Algorithms and the Political Economy, “…We are overweight Energy via leadership companies across the sector as being likely to dominate as the industry emerges from restructuring with oil prices in our $ 60-70/ Bbl. WTI target range. Solar panels and applicable tariffs have been making the political news on fair trade. When compared to the hitherto dominance of hydrocarbons and that of coal a century ago, alternate generation methods are likely to increase in importance as energy sources. However energy change has always been measured in decades and not in immediacy. It is even more so for the myriad products from high technology to pharmaceuticals to kitchen utensils that include components based on manufactured polymers. Meanwhile amid more constrained supply, the International Energy Agency and others point to rising hydrocarbon demand from emerging countries. OPEC members as well as major external producers like Russia appear to be more circumspect about increasing production and indeed have held numerous meetings likely coordinating supply. Shale oil as major disruptor remains a force with the United States as major producer but for self-preservation and finance reasons alone, shale production appears as less of a free for all. Therein seems to us to lie the evidence for the energy industry as now shaking off the severe restructuring stress that gripped the industry for close to a decade. From a recent 2016 low close to $25/Bbl. WTI after a high close to $145/Bbl. WTI a decade before, crude oil at $68/Bbl. WTI has entered into our target stable zone of $60-70/Bbl. WTI of balancing back supply from less efficient sources against rising demand. Crude oil prices are not likely to reignite free for all behavior but seem high enough to benefit leadership companies across the sector. Such companies are after all well versed in risk assessment and in being opportunistic in asset acquisition…”.
Notwithstanding the hoopla, wholesale hydrocarbon displacement seems not to be imminent. Simply stated, hydrocarbons play a crucial role in both the usage of energy and in the production of goods from pharmaceuticals to information technology to kitchen items. Their production from say biomaterials is still in the infancy of an evolution that is likely to be at least two decades long. Throughout its history, oil has been a political commodity from its discovery in Petrolia to expansion into Texas/Oklahoma , the Middle East, the North Sea, frontier regions and most lately in shale oil. It becomes more so as Iran, Iraq, Venezuela pressures reemerge and Russia flexes. The same can be said for natural gas that has become widely transportable, only comparatively recently. Since 1973 and increasingly so in recent years, a strong market component has added onto crude oil politics. We have assigned a trading band of $60-70/Bbl. WTI as a likely volatile balance between production excess to be contained against rising demand due to global recovery. It presages that not all energy companies stand to benefit and restructuring is still occurring.
A multipolar jolt and grind capital market environment appears in place. In that respect, rather than capital market pullbacks being dismissed as temper tantrums over policy as in 2013, we would regard them as indicative of quality of delivery and of financial strength as being imperative in investment considerations. Investment advantages likely also include strongly financed energy companies that have severely restructured already- dovetailing into our portfolio strategy favor for restructuring, quality and value.
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.