Category: Financial Markets

Consensus analyst expectations much too high for 2021.

P/E at +1.3 std dev and P/CF at +1.7 std dev is now outside +1 std dev band strongly signaling over valuation

“August retail sales rose by 0.6% relative to July, marking the slowest monthly increase since April. Sales in sectors such as groceries and online retailers were boosted by stay-at-home restrictions and are above pre-pandemic levels. By contrast, while sales in restaurants and bars rose a strong 4.7% last month, reflecting a gradual resumption of their activities, they remained below levels seen in February. This suggests that the services sector is still under pressure from social distancing behavior. On a year-over-year basis, retail sales are up by 2.6%, but momentum slowed in August, coinciding with the expiration of the $600 extra weekly unemployment payments. Services spending will likely remain depressed until we see the widespread distribution of a vaccine. This should contribute to a general slowing of the economic recovery.”

Ten year real yields are negative and among the lowest in past 50 years

Fed has little ability to reduce rates further other than negative rates which are unlikely. Ongoing quantitative easing to continue to keep rates near zero. Pace and amount of bond purchases to watch.

Oil prices recover. Storage tanks, pipelines and tankers no longer overwhelmed. OPEC action buoys market.

Dollar strengthens, trade deficit shrinks and developed market interest rates converge.

June adds 4.8 million jobs dropping unemployment to 11.1%. However post mid – June coronavirus rise effects not captured.

Too early to tell which factors will outperform in 2020.

Sectors impacted by low oil prices, materials, discretionary and industrial have performed poorly. Health-care, staples and utilities have held up.

 

Value stocks are priced cheaper than growth. Market expectations of economic growth are low for 2020 and value stocks have historically outperformed in similar environment.

Cash being conserved as over a quarter of companies suspend buy backs. Negative earnings to pressure dividends. R&D and Capex cuts. M&A activity slows.

“Deals Resume in Sale of Risky Loan Funds” The WSJ, Tuesday June 30, 2020, B9.

CLO sales cross $34 billion YTD, $5 billion in June alone as investors re-enter the risky loans market. The Fed’s corporate debt buying program is catalyzing U.S. investor appetite seeking higher spreads ( AAA at LIBOR+1.65) , even as Japanese institutional investors curtail risk taking and have been pulling back.

In 2020 CLO investors need to be especially hands-on to understand the origination processes, servicers, borrowers and quality of underlying collateral. Quality and performance of the underlying collateral is worsening materially more than expected, suggesting that the underwriting process did not consider severity of coronacrisis induced slowdown. In many cases originators had created loans primarily for sale and retained little, if any, interest in ongoing performance. Investors also need to get more deeply involved in the information cycle where excessive reliance on lagging ratings doesn’t help. In the 2008 global financial crisis default and delinquency data was artificially low because of extend and pretend and refinancing. Reliance on historical performance data and statistical models and stress test is insufficient. Investors need to manage the risk that their models are becoming irrelevant to changing conditions in the underlying loans space.

Wall Street Journal, June 29, B1 article “Debt From American Companies Lures Asian, European Investors”.

U.S. corporate debt  now much riskier as default rates rise, but Asian and European investor demand is very high. Fed backstop expectations prompts switch from holding low yielding treasuries to higher yielding corporate debt.

Here is quick way to begin to arrive at the share repurchase decision

Response to WSJ, Monday, June 8, 2020, ” Why Many People Misunderstand Dividends, And the Damage This Does”

We agree and opine that with earnings and therefore dividends  to remain low, companies should reduce outstanding shares to increase per share price through share buybacks. They ought to return value to shareholders through buybacks rather than dividends and provide investors the option to benefit from continued appreciation and defer taxes by selling shares at later date. We compare and highlight the benefits here.

Direct relationship between share repurchase size and excess returns at announcement. Multiple re-purchasers benefit more from large repurchase announcements. Smaller buyback announcements tend to be anticipated and partially priced in. Market reaction to buyback announcements is the uncertainty about whether the buyback will be executed. Larger repurchase correlated with greater abnormal return.

The coronacrisis may well be a  watershed moment – both business mix and key players are likely to change. Development strategies will involve regional and global positioning for flow and advisory business; developing new products and market capabilities as well as going offshore. Meanwhile exchanges further consolidate faster than ever before as the world gets even more networked.

Low 2020 EPS and very elevated 2021 consensus growth estimates makes 21x P/E hard to justify.

Oil prices rise to $33. Storage crisis easing. Supply curtails to 11.5 million b/d. Fuel demand increases and stockpiles reduce 5 million barrels. States ease lock-down and travel rises.  Demand uptick matched with OPEC supply cuts, and U.S. wells shutdown. But gasoline demand is still soft, and outlook is still fragile with low prices discouraging production.

ActiveAllocator dynamic constructed portfolio over-performed the 60/40 portfolio by 300 percent YTD. Over-performance attribution from reduction in maximum draw-dawn, arresting negative skewness, wider asset class universe, active active management. Adding typical financial advisor fees of +1% further increases differential in performance.

YTD ActiveAllocator +6.34%

YTD 60/40 Blend        -3.1%