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Increased concern around Coronavirus has Impacted Bond and Equities
This week has seen complacency about the impact of the Coronavirus shattered, US Treasury yields have fallen across the curve and the Global Equity sell-off has shifted from selling Cyclicals to investors focusing on selling last year’s winners.
The short term moves in Bond/Equity Yield Ratios should signal a rally
The combination of the equity sell-off and low bond yields has taken the short-term Z-Scores of the Bond / Equity Yield Ratio to levels that have previously seen investors decide that ‘There is No Alternative’ to switching back into Equities.
This is a critical point – a failure to rally here could signal major risks
Elevated volatility across Equities, Bonds and FX, as well as Bond/Equity valuations, should trigger a risk asset rally. If, however, a rally is not sustained and supply-chains are disrupted, Equity risks are substantial. We remain defensive for now.
Rising corporate inequality is leading to increased corporate fragility
Although Coronavirus briefly dented the rally seen since January 2019, markets are back to favouring US equities and Growth stocks. The focus on a narrow range of stocks is leading to increased corporate inequality between the winners and losers
We see more divergence in Corporate Debt, Earnings and Valuations
However, there is a risk of the US experiencing the ‘Dutch disease’ as US Tech dominance hollows-out other sectors, resulting in increased corporate fragility due to divergent trends in debt, earnings, valuations, access to capital and employment
We are monitoring potential catalysts to trigger a rotation in strategies
We expect current sector trends to continue for now. However, potential catalysts for change range from earnings disappointments in high PE stocks, to a reduction in ad-spend or disrupted supply chains as small caps falter, or higher bond yields
US Buybacks are Highly Concentrated in Just 25 Companies
With a current run rate of over $700bn, share buybacks are the biggest source of liquidity in the US market. Repurchases are even more concentrated than profits and Market Capitalisation and just 25 companies account for over half the total.
Profit Growth Cannot Offset Unsustainable Rise of Distributions
The US tax reform unlocked foreign earnings, but rather than invest, these 25 companies have accelerated buybacks. They now hold net debt as their holdings of cash have been drawn down, with distributions being higher than profits.
Level of Buybacks Unlikely to Recover as Cash Holdings are Falling
These stocks still have over $500bn of cash and are currently growing profits, so we do not see an imminent halt to their buybacks. However, given falling cash reserves, buybacks are unlikely to rise to the levels reached in 2019 any time soon.
The UK has left the European Union: What Next?
More than three years of prolonged and chronic uncertainty has undermined UK assets. But Boris Johnson’s emphatic election victory has delivered Brexit. However, what remains to be settled is the UK’s future relationship with the EU.
Focus to Turn towards Radical Microeconomic Change
The economic rationale for Brexit lies in a belief that the UK can create a more optimal regulatory environment than that offered by Brussels. It demands that the UK actively diverges from EU’s regulatory environment. It’s about micro not macro.
UK Equities: Undemanding Valuations in Search of a Catalyst
We think the UK faces a trade rupture next January even if there is a UK-EU Free Trade Agreement. Investors should therefore focus more on the upcoming UK Budget for signs of a commitment to radical productivity-boosting initiatives.
Eurozone Equities – Searching for Catalysts
In a week where the market capitalisation of Apple exceeded that of the DAX index, we decided to look at eurozone equities. For the first two decades, eurozone policymaking has favoured bond holders; we explore how that might change.
Investors may be Underestimating the Pace of that Change
The eurozone is (1) reviewing monetary policy; (2) revisiting fiscal activism to address climate change; (3) under pressure to change the fiscal - monetary policy mix; (4) facing its own Brexit shock; (5) vulnerable to US-China rivalry
These Drivers may not Kick in until Next Year; France a Beneficiary
These are medium-term drivers which may not start to kick in until next year. But they should present investment opportunities. The knee-jerk reaction suggests that France ought to be a major beneficiary; but equity valuations look too rich for now.
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