April saw significant volatility across global markets, as lackluster Q1 US GDP reports unnerved investors, and recent leaders on Wall Street, including transportation and biotechnology stocks, decided to take a pit stop. On the bright side, US wages finally moved upwards, indicating possible labor market tightening – and consequently inflation – ahead. This week, the US jobs report will be the center of attraction as investors continue to figure out the timing of interest rate hikes and the impact of international easing measures on the US economy. Meanwhile, as earnings season rolls on, the effects of oil prices and currency moves on earnings and revenues keeps Wall Street busy. In line with our belief that several stocks were priced to perfection leading up to the recent weeks, Twitter, Yelp, and LinkedIn fell over 20% in a single day after weak earnings reports. Meanwhile, Carl Icahn, over the weekend, reminded Wall Street that the high yield junk bond market was in a bubble – voicing our concerns, given that the asset class is the 2nd best performer (after emerging markets dollar debt), returning 7.7% annually over the past 15 years. Risky assets have been major beneficiaries of low interest rates. Our opinion remains that the market will continue to be sensitive to policy statements and jittery trading – as while everyone wants to ride the wave higher, it’s going to be an every-trader-for-him/herself situation when the plug gets pulled. Being cautious and selective is the key to taking 1-2 year positions, and it’s best to leave aside policy projections and focus on finding the underlying strengths in the world’s markets while choosing investments. Here are the two subjects we’re highlighting this week:
M&A Activity: Corporations continue to stash cash at record levels as a percentage of their total assets, and cost-cutting measures have proven pretty successful, considering profit margins are at multi-year highs. With global growth projections still looking weak, we reiterate our opinion that M&A activity will remain high on the radar for both activists as well as companies. According to Wells Fargo’s Gina Martin Adams, ‘the average company in the S&P 500 index involved in a transaction has outperformed the benchmark during the month after the announcement in each of the past 3 years’, showing that investors have rewarded the fact that this may be among the few ways to achieve growth at the moment. Also, according to Credit Suisse’s Andrew Garthwaite, ‘the stock market doesn’t peak until about eight months after a merger boom crests’ – and we don’t think we’re anywhere close to that stage yet. While finding undervalued targets is a way to benefit from the activity, the financial industry should continue to reap the rewards from such transactions – and although the sector hasn’t really done much this year, we reiterate our opinion from our February 8th column that the bargain prices continue on banks.
China: The Chinese stock market remains among the most watched indexes this year, as investors attempt to dissect the impact of structural economic growth and recent policy decisions. Chinese stocks have more than doubled over the past year, aided by policy changes involving the encouragement of retail investing, a broader currency trading range, and market liberalization measures aimed at enhancing foreign investment. According to Barron’s Kopin Tan, ‘Shanghai stocks fetch 22 times trailing earnings, versus 49 times in 2007’, and many analysts believe this is just the beginning of a massive bull run as China adjusts to a slower, but more solid domestic-driven economy. While the enthusiasm is pretty high on Wall Street, our concerns, however, linger around the ability of local companies to furnish their high yielding debt obligations in the coming months, the possible implosion of overvalued real estate, and the pace of the economy in transitioning into a consumption-driven one. Charles Schwab’s Jeffrey Kleintop recently highlighted how the demographic changes mirror those of Japan in the 1970s and 80s, and therefore, the working age population ‘is peaking and set to decline in the years ahead’. China’s capital markets find themselves at a very interesting juncture for these reasons, and while the market remains high on our radar, we prefer to understand how the concerns above are mitigated in the coming months before going all-in. At the same time, there’s no doubt that the transition into a consumption and service-driven economy will occur, and therefore, adding exposure to consumer-driven stocks provides a good risk-reward scenario.
What it means for you: The coming weeks are set up for some serious short-term action, with the jobs report on Friday, along with the much-discussed summer under-performance that has occurred historically…occasionally. We aren’t paying attention to this stuff, and prefer to bet on the structural trends in the global economy. A broad exposure to the world’s equity markets via ETF combinations such as SPY and VXUS, is the simplest foundation upon seeing the historical trend of markets to deliver in the long term, given global population growth, productivity improvement, and increasing utilization of comparative advantages through cross-border trade. As for structural sector changes, it’s worth listening when the visionaries speak. In a 2013 McKinsey interview, Google’s Eric Schmidt stated that digital biology would be among the biggest trends to watch in the future. In recent years, the immense interest in fitness apps, healthier food, tracking features of the Apple Watch, objectives of companies such as Under Armour, and surging biotechnology venture capital all attest to this being a structural trend. The quest for a better – and longer – life, isn’t going anywhere, and this is a change worth being invested in. Sit back and move ahead with the world while Wall Street attempts to figure out the direction in the coming weeks.
