Thursday, April 30, 2015

Sell in May...?

It looks as though we're entering the May doldrums smack on schedule. Somewhat sluggish macro data from the US combined with lacklustre Q1 earnings numbers are all pointing towards a continued flatline for the US market and perhaps, by extension, most others too? The sharp weakening in the USD over the course of the second half of April seems to reflect this with the USD index falling by 3.5%, and the EUR rising back over the 1.12 level by month end.

There is no doubt that markets are not as cheap as they were. US corporate earnings have not accelerated as fast as their QE inflated share prices, so valuations have risen, and this rise in valuations has been reflected in the fact that, after a strong 2014, the US market is little changed from its start point at the beginning of 2015.

Elsewhere, however, the picture is rather different. In Japan, corporate earnings look headed for another strong year, and the market continues to look good value: Japan remains one of our core market picks for 2015, particularly if you hedge out the risk of a what we think will be a continued depreciating Yen. In Europe, too, notwithstanding deserved concerns about the future of Greece as a Eurozone and EU member (we still feel that despite Athens' rhetoric a pullback by the Greek government from its anti-austerity position is unavoidable and inevitable), the earnings picture is improving. The UK faces an uncertain political environment, but at a company level, the earnings outlook is still favourable.

Asian and Emerging Markets have also done well this year, assisted by a (mostly) stronger USD. The surge in China's markets (up 40% in 2015 thus far) has been little short of remarkable from the lows of March 2013 (the predicted China market crash - a favourite theme of many US hedge funds last year - seems to have mysteriously failed to appear thus far). We continue to like these, although acknowledge that any global market volatility would likely have a negative effect in the short-term.

So - in general terms we remain long equity. Our moderate risk portfolio has an equity allocation of 65%, and is neutrally weighted towards the US, whilst being overweight Japan, China and India. 

However, we acknowledge that in the short-term we could be looking at some profit taking which could result in a 5% or even 10% pull-back. For the nimble with perfect foresight, it might make sense to try and capitalize on this. 

For the rest of us, experience has shown that such pull-backs are over almost as quickly as they begin. Timing those perfect entry and exit points will be almost impossible, and it's important to reflect what the alternatives are in the meantime. Would we recommend sovereign bonds at these levels? No: negative yields strike us as having negative attraction. Commodities? No: whilst there has been some recovery in some core industrial commodities, inflationary pressures and fairly low demand seem unlikely to get these motoring any time soon. Cash? Only on a short-term basis and only when biased towards the USD (its recent weakness notwithstanding). 

That leaves us with equities as the default option for investors, as they have been since 2009. 

Our view on this is not swayed by continued predictions by many pundits that markets are heading for a substantial fall - they've been saying the same thing since 2009, and as they have continued to say while markets have risen through successive all-time highs ever since. If they've been as short as they have implied, then they should have gone bust some years ago: either they are keeping quiet about this or their actions differ from their words.

Our simplistic view is that there remains too much cash sitting around on the sidelines not to have this deployed on any marginal pull-back to make this likely, even though we acknowledge the short-term risks that would be created by a rise in bond yields should US interest rates rise more sharply than expected. Recent US data and subsequent pronouncements from the Fed suggest that this is unlikely: "lower for longer" or "lower for ever"...?



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Tuesday, February 24, 2015

Loadsa money...

A good research piece from one of the Swiss banks this week suggests that market consensus is probably underestimating the tidal-wave balance sheet effect of the more than $1tn in globally generated after-tax corporate earnings per year. 

Since the financial crisis, non-financial corporates have been de-leveraging balance sheets through an unprecedented accumulation of earnings, and a relatively conservative approach towards debt issuance. At the same time "cash outgoing" activities such as capex, M&A, buybacks and dividend pay-outs have failed to keep pace with the balance sheet cash build-up. 

Since 2009, while total global non-financial corporate debt has increased, leverage (defined here as net debt to equity) has declined consistently to historical lows around the globe. What this means is that although the dollar value of debt has gone up, the rate of increase in the asset base (as a result of increased cash retention) has gone up faster, so that corporate leverage has actually declined.

In addition, the global low-rate environment has encouraged CFOs to take advantage of low interest rates to extend their corporate debt terms much further out, with the result that corporates are now net providers of short-term funding to the market.

Investors should focus on the following potential consequences: 

1) market premiums will grow for an increased level of share buybacks and dividend pay-outs; 
2) there will be a re-assessment of benchmark cost of capital calculations and market multiples, as long-term leverage ratio expectations get reset as cost of capital goes down, the market risk premium should decline to, justifying higher valuations overall); 
3) even higher future premiums for corporates who have shown a disciplined approach towards value-accretive M&A and capital expenditure projects; 
4) a decline in corporate credit spreads if low-leverage capital structures become the new norm; and 
5) unused corporate funding or cash attracting a significant level of activism or governments looking to tax large pools of cash. Activist funds in the US have been particularly focused on this issue, with some success. 

Our view is that this has been a long-standing theme and one which will remain so for some time, even if US interest rates start rising in the second half of 2015 (if that happens, we don't believe that it will be much more than a couple of token adjustment just to show that the Fed can...).

There are a couple of ways of playing this theme through ETF's that focus on companies that are part of buyback or high dividend paying indices. We already own those. We're also looking for the same in Japan, where the build up of cash continues to support this concept in the context of Japan's steadily improving earnings environment (Nikkei index constituents have just registered the ninth consecutive quarter of higher than expected earnings).  

Steve & Justin
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Javelin Wealth Management supports the global microfinance philanthropy initiative, the education charity,, and the Singapore Children's Cancer Foundation, New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.