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WCM COTW for May 8, 2019

Interest rate spreads in the US High Yield bond market have risen recently after narrowing some 130 basis points since the beginning of the year.  While that is a concern, we point out that current readings are still below trend.  Comments from Pres. Trump over the weekend regarding tariff increases in trade negotiations with China have rattled stock and credit markets around the world and undoubtedly contributed to the near-term widening of US High Yield spreads.  How these negotiations play out towards the end of the week are critical for the capital markets. Key components of the earlier discussions – intellectual property protection, dispute resolution enforcement and freer market access – may be in jeopardy or be diluted. That could lead to economic disruption and derail the recovery in risk asset classes we have experienced so far this year.

WCM Chart of the Week for May 2, 2019

Bloomberg maintains a series of global and regional financial conditions indices that combine several key fixed income and equity market metrics such as interest rate spreads and volatility.  Taken together, this data gives an indication of how benign or strained conditions are in the capital markets. Currently, the reading in the US is positive, indicating a benign environment for risk asset classes.  It is important to recognize this indicator can maintain long periods of positive or negative readings but when it begins to move in a downward direction capital markets become stressed.  US financial conditions could continue to remain in a positive state due to favorable economic trends — low inflation, accommodative monetary policy, strong productivity gains, high labor participation and robust GDP growth.

WCM Chart of the Moment

A little off-schedule so we’ll call it the Chart of the Moment. Based on Standard & Poor’s indices, the rebound in US technology stocks since the beginning of the year is an impressive 27.8% while the overall equity market has advanced 17.5% through April 24th.  US technology companies play a critical role in the American economy and the sector is the largest in the US equity market based on capitalization. Further gains of US equities overall largely depend on tech sector performance and valuation readings are approaching historically high levels. We show the technology sector along with its price-to-cash flow (P/CF) valuation metric.  The current P/CF is 16.2 which is below last March’s five-year high of 17.6 but still in an area where the sector has struggled.  We are currently in the midst of the US earnings season, and if technology companies can continue to deliver strong earnings and cash flow, share prices should advance further. (all data citations as of April 24, 2019)

WCM Chart of the Week for April 17, 2019

The Eurozone has faced several roadblocks to growth since the Financial Crisis ranging from the debt crises in Italy and Greece, to the uncertainty related to Brexit to stubbornly sluggish economic growth.  We have been concerned that economic conditions on the Continent would strain corporate performance and therefore we have not been fully committed to Eurozone equities for quite some time even though the region has favorable valuations compared to global peers.  Now there may be positive trends developing.  This week’s chart shows Citigroup’s Earnings Revision Indices for Continental Europe and the Globe.  The latest reading for Europe was flat while the World registered -0.12.  Both indices appear to be trending towards positive revisions which could provide a key underpinning for further gains in global equity markets.  If positive developments continue in the European corporate sector, investors may rotate funds into the region.

Chart courtesy Bloomberg LP (c) 2019

WCM Chart of the Week for April 10, 2019

We’ve been proponents of Environmental, Social and Governance (ESG) investment disciplines going back long prior to founding WCM and it is one of our key investment offerings.  A common misperception is that ESG-related investing is prone to significant underperformance due to limitations in order to achieve ESG compliance. This week’s chart shows the total return of the MSCI World ESG Leaders Index and the MSCI World Index over the past five years.  Generally, the two indexes move in a similar direction and over the five year period ending last quarter the annualized performance differential is about 0.2% in favor of the broader index, but the performance differential is not persistent. This is the most naive way to look at ESG investing, but it decisively busts the myth that there is an automatic ESG penalty.

Chart courtesy Bloomberg LP (c) 2019

WCM Chart of the Week for April 3, 2019

Purchasing Managers Indexes (PMIs) are now signaling expansion in two of the world’s largest economies as China’s reading joins the US measure in positive territory.  China’s rebound from negative territory may be an early indicator that expansionary monetary and fiscal policies are beginning to take effect. That’s welcome news.  However, the Eurozone PMI is continuing to deteriorate with disappointing results in the German and French manufacturing sectors.  The lack of pro-growth fiscal policy in the EU is still a major drag on economic vibrancy.  That said, European bourses have posted robust returns so far this year although not as strong as US counterparts.

To Brexit or not to Brexit

That is the question. Whether ’tis nobler in the mind to suffer the slings and arrows of outraged citizens, or to take votes against a sea of troubles, and by opposing end them?

We have been watching this theatre of the absurd since the exit vote passed, with calumnies hurled back and forth, plans drafted and shredded, ministers appointed, ministers departed, political lines in the sand drawn and redrawn, and no actual progress on either following or revisiting the will of the people. Parliament is so feckless they cannot pass a vote to move in any direction, nor can they muster the support to remove the leadership and try something else. Fortunately for the markets, even with trouble looming on the horizon, the net of doing nothing is that the status quo remains. It appears March 29th will come and go without any action beyond resolving the intent to plan for a discussion about the plan. Monty Python could not have written it better.

What to do?

There is simply no way the UK is going to stumble toward Brexit without some form of roadmap in hand. There are too many unmanaged and ugly consequences otherwise, from re-establishing a hard border between Ireland and Northern Ireland to trading internationally, even across the Channel, with no trade accords. With various structural events between now and Summer including the EU parliamentary elections in late May, there are plenty of reasons and plenty of opportunities to do something, even if that something is to resolve to do nothing. It may be that staring into the abyss is enough to compel the UK and the EU to address the Queen’s subjects’ major concerns around immigration, home-rule, etc. through the parliamentary and rulemaking process and belay or even ultimately put aside an exit. It could also be that the UK finds a way to rescind Brexit through whatever constitutional means are at their disposal.

But what if they do stumble out the door with no plan or path? It would be ugly and intensely unpleasant for everyone and may re-open old geopolitical wounds, but the free markets will price the new reality and, as the Brits say, carry on. We have seen a threat to asset prices in the UK and EU and have been significantly underweight relative to our policy benchmarks, although not exclusively for those reasons. Europe appears to be sputtering, including in economic powerhouse Germany, which has given us ample reason to believe the near term opportunities for investors are in North America and Asia. If the UK gives Europe Her Majesty’s middle finger, that could unleash instability and a repricing as markets try to find a new equilibrium based on conditions that have not existed since before many market participants got their educations and first jobs.

What we can do right now is watch closely. A disorganized Brexit could send markets into a period of significant turbulence. An orderly and well structured Brexit, or even no Brexit at all, could potentially herald a new moment for stability and growth and a reason to consider reinvestment in the region.

WCM Chart of the Week for March 22, 2019

After the conclusion of US Federal Reserve’s scheduled meeting, Chairman Jerome Powell said that the Fed has reduced their planned Fed Funds rate increases to zero for the year by a unanimous 10-0 vote. Additionally, he announced that they would begin slowing the pace of balance sheet contraction beginning in June from $30 billion to $15 billion per month and end the planned shrinkage by September. These developments were received favorably by stock and bond markets because it signals that accommodative monetary policy will be supportive of asset prices. Investors have been concerned over the past several months that the Fed had adopted an overly restrictive monetary stance while economic conditions in the US were exhibiting signs of softening which could lead to recession.  This week’s chart comes to us from the Bloomberg Economics team and shows the relationship between real US GDP growth and the real Fed Funds rate along with recessions going back nearly 50 years.  The point the team makes is that, historically, the economy has yet to head into a recession with the real Fed Funds rate at current levels, and it is not until this key rate exceeds real GDP growth that a recession follows. Those occurrences are highlighted in the circles on the chart and do appear to be an early warning of recessions. We may have a fair amount of time before seeing those conditions develop.

Chart courtesy Bloomberg LP (c) 2019

WCM Chart of the Week for March 13, 2019

Since the S&P 500 bottomed on March 9, 2009 in the aftermath of the Financial Crisis, the index price has risen over three-fold and the MSCI World Index has doubled.  Disappointingly, European shares have risen only one-third of the S&P’s price gain in the same amount of time and lagged global equities considerably.  The question in our minds is whether this is a permanent condition or will European shares become competitive with other global equity markets.  European equities do offer compelling valuation measures, particularly versus the US, but the macro pressures facing the Euro region, the uncertain outcome of Brexit and the absence of fiscal policy support may limit the price appreciation of shares in the region.

WCM Chart of the Week for March 4, 2019

South Korean exports contracted over 11% over the past year marking the second consecutive month at negative levels.  Many view this economic data series as an early indicator of global trade.  South Korea is an export powerhouse with trading relationships throughout the world and region, particularly China and Japan.  What is critical in our view is how long this trend persists — the contraction in Korean trade could turn out to be intermittent, fluctuating with periods of expansion as was the case in 2012-2013, or it could signal a more prolonged contraction with recessionary conditions that occurred during several periods over the past 20 years.  Chinese economic growth will be a key factor and some see reflationary monetary policies gaining traction later this year and it appears that purchasing managers indices may be stabilizing, albeit below expansionary levels.

Source: South Korean Ministry of Trade, Industry and Energy
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