Market Commentary – June 2018
“Opportunities are like buses, there’s always another one coming”
– Sir Richard Branson
Global Equity Markets, which performed so flawlessly in 2017 are back to their old tricks. The US equity market once again in 2018 seems to be playing its old part of being the best house in a not-so-great global neighborhood. GDP growth in Europe, Japan, China and many other Emerging Market countries seems to be slowing – while the US is enjoying record unemployment and consumer/business sentiment figures that are some of the highest in recent memory. The US tax cut – love it or hate it, has also made more cash available to US Corporations as they decide whether they want to make capital investments in their existing businesses, conduct M&A to gain scale or return cash to shareholders via share buy backs and dividends. Finally all of this good news for the US has sparked a reversal in the downward slide for the US dollar vs. most major currencies as capital flows into our economy to purchase our debt and interests in our businesses.
Looking at the US equity market sub-sectors, Technology continues to lead all sectors of the market. Technology now accounts for over 26% of the market cap of the S&P 500 – when was the last time we saw Technology take such a dominant share of investor dollars? 1999-2000… While tech companies today are being valued by profits and at worst sales instead of eyeballs as they were in the last Tech Boom, it begs the question that perhaps other parts of the market may be starved for capital and present compelling buying opportunities. We have been most surprised by the lack of participation in the recent rally by the large Financial Stocks. We were told that the loosening of regulations, the lack of need to reserve profits toward capital cushions and rising interest rates were catalysts to take this sector back to it’s glory days of 2005-2007. Alas even with these tailwinds and in our view very inexpensive valuations on many of the participants in the group whether they be through a relative or historical looking glass, these stocks cannot catch a bid. It begs us to ask why? Yes, it’s true that financials are considered an “Early cycle” group and after close to 9 years of an expanding economy we would argue that we are no longer in the early innings of our economic expansion, but many of these stocks are playing catch up to the rest of market after taking a beating in the financial crisis. We believe the market may be discounting other more ominous outcomes that could include the following 1) A yield curve that may invert in the coming quarters – higher rates are a plus for banks, but most important is a positively sloped yield curve (One where long rates are higher than short term rates) – Traditional NIM (Net Interest Margin) is predicated on paying depositers lower short term rates and lending money out at longer term higher rates 2) Jobs gains are peaking and about to roll over – people without jobs become delinquent on payments which ultimately result in loan losses for the banks 3) The Global Economy has peaked and has begun a slide into a recession that could occur sometime late 2019 – ultimately causing losses on the corporate level as over-levered corporations default on loans from financial institutions 4) Italy can’t form a govt. and they ultimately leave the Euro and decide to default on their debt causing a huge ripple through the global banking system. While any of these could be viable reasons, we suspect the market is pricing in a continued flattening of the yield curve at current as the Federal Reserve seems determined to keep hiking short term rates, while long term rates in the US continue to see willing buyers as rates in Europe and Japan are still incredibly low.
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