Monday Digest
Posted 7 September 2020
Overview: Are investors finally running out of positive sentiment for tech names?
The holiday period for investors is over. While risk assets made impressive gains throughout August, catapulting equity valuations to eye-watering levels, last week brought a sudden and sharp reversal. Apple, which made history a few weeks ago by becoming the first company valued over $2 trillion, lost $219 billion in midweek trading alone. The incredible performance of US mega-cap tech companies has led to some investors getting vertigo, worrying about climbing valuations as hitherto healthy underpinning earnings are proportionally becoming ever smaller relative to share prices. This fear could well have been a part of last Thursday’s sell-off. Momentum carried America’s most-bought companies higher throughout August, but this momentum petered out for the rest. For the Russell 2000, this sluggish pace led a ‘double top’, where the short rally into the end of August was not enough to break past the highs seen earlier in the month.
In fact, the distance between America’s haves and have-nots becomes even more stark when comparing sectors on a regional basis. As a whole, US equities have outperformed their global peers over the last three months. But at the sector level, non-US markets have outperformed their US counterparts in eight out of the 11 major sectors. For the tech superstars and the consumer discretionary sector, the US is looking good – but not so much for everyone else. This is an unhealthy sign. Much has been made of the supposed ‘K-shaped’ recovery we are seeing in stock markets, where the winners recover quickly from the economic crisis and the losers languish at their lows for much longer. We certainly see signs of this in the US market – and it does not bode well for overall stability.
The US still leads the world for now, but the underperformance of large sections of the American economy – combined with weakness in the US dollar – could be a sign that investors are starting to look elsewhere. But while last week’s sell-off has pulled the superstars back, pronouncements on their fate are premature. Even if current big tech companies are overvalued, their underlying popularity is based on impressively strong and stable profits – unlike the overbought start-ups with non-existent revenues 20 years ago. For now, the break in US tech’s relentless rally comes as something of a relief. Given some early signs of a cyclical recovery – especially in Europe – a volatile September could be the precursor to a rotation away from US large tech, the market’s current (and seemingly only) investment darling.
Here’s why China is now an ‘inflation exporter’
We are in a new era for central bankers. US Federal Reserve (Fed) Chair Jerome Powell’s speech at the ‘virtual’ Jackson Hole Economic Policy Symposium was noticeably different from previous years. Breaking from past policy, the Fed is doing away with its strict target of 2% annual inflation and instead moving to an average target – allowing more flexibility. This means, in effect, that monetary policy will stay easy for the foreseeable future. Judging by the reaction from capital markets, Powell’s announcement has already gone some way to raising inflation expectations – if only marginally. But it also raises questions about why central bankers have allowed inflation to stay so low for so long.
A sluggish economy and slow price movement have been the hallmarks of the post-financial crash world, but inflation was subdued even before then – undershooting that 2% target almost every year since the late 1990s. One of the key reasons for this persistent disinflationary environment is the intense increase in globalisation – and in particular the rapid rise of China. Since joining the World Trade Organisation in 2001 the ‘factory floor of the world’ has been able to produce goods faster and cheaper than any of its global peers can compete with. Aside from catapulting China’s economy – now the largest in the world on a purchasing power basis – upwards, this has effectively put a cap on prices in developed economies. In other words, China has spent the last two decades exporting disinflation to the rest of the world.
Right now, despite the world sinking into its deepest recession in history, and global trade plummeting, growth in China’s export prices has picked up. Having gone through its lockdown earlier than most countries, and implementing draconian measures to avoid re-importation of the virus, it looks in a relatively good position– and its government is now focused on getting its domestic economy going. Sanctions, further tariffs and the possibility of military confrontation remain big risks, but recent market action suggests that investors are relatively positive on China.
In terms of global inflation, we may be at the beginning of a sea-change, even if it may take several years to feed through. The Fed is now trying its best to push inflation expectations higher over the long-term – with other central banks expected to follow suit. And this is happening just as one of the major secular causes of disinflation could be coming to an end. Undoubtedly, other developing countries will pick up the export slack to some extent – as we have already seeing with Vietnam’s rapid manufacturing growth in recent years. But deflation is no longer ‘Made in China’, and that is a significant turning point. With the world in the depths of recession, short-term price growth is unlikely – but the structural forces of disinflation are fading.
Reasons why September could prove the decisive month of 2020
While governments have supported national health systems across Europe to be ready for a return of April’s misery and tragic, they have repeatedly stated that they are not planning on a return of nationwide economic activity lockdowns – most probably because the minimal impact on public health does not justify such a step. So, if the current state of the virus and/or our ability to deal with the illness continues to limit the wider health impact to what currently looks no more than a mild summer flu then it will be down to societies’ changing behavioural response to the virus threat that will determine whether the economy will continue to rebound as strongly as it has over the summer, stall, or revert back to decline.
Looking forward, September carries huge significance. If the gradual return of children to classrooms, and workers to offices, continues in positive fashion then the economic recovery will gain some traction. However, should the climate of fear return, economic prospects will be much harder to foresee, and so will the corporate earnings recovery. We believe that the positive scenario carries a higher probability than the fear scenario, but it is entirely possible that over the coming weeks, stock markets will be buffeted between these two opposing economic prospects. The roller-coaster stock markets we experienced over the past week may therefore become much more frequent than it has over the summer months.
From an investment perspective, should the US situation become messier the closer we get to general elections, markets could well get much choppier over the coming weeks and months. If, at the same time, we see early signs of economic recovery, this may not be such a bad thing, with financial markets coming more into line with economic reality. If those signs do not come through, further fiscal or monetary action will almost certainly be necessary.