Corporate Profits
Highlights Stock markets are set to produce low single digit returns in 2020. Favour stocks over bonds and cash, especially where bond yields are zero or negative – specifically, Germany, Switzerland, and Sweden. Underweight zero and negative yielding high-quality bonds versus higher yielding bonds – for example, underweight Swiss bonds versus US T-bonds. Favour lower yielding currencies because the central bank loses the ability to depress its own currency. For 2020, our preferred expression of this is long SEK/USD. The biggest risk in 2020 is if the global bond yield were to rise towards 2.5 percent exposing the fragility of risk-asset prices to higher bond yields. The $400 trillion global risk-asset edifice dwarfs the $80 trillion global economy by five to one. Fractal trade: Short Ireland (ISEQ 20) versus Europe (Stoxx Europe 600). Feature For all the talk of economic growth driving stock markets, the big story through 2018-19 has been bond yields driving stock markets. This is true in Europe as well as more broadly – and it is very easy to demonstrate by decomposing the stock market price into its two components: the underlying profits (earnings per share) and the valuation multiple paid for those profits (Chart of the Week). Chart of the Week2018 And 2019 Were All About Valuations. What About 2020? 2018 And 2019 Were All About Valuations Contrast 2018-19 with 2017. In 2017, the stock market’s stellar return came almost entirely from growth – profits surged while the multiple drifted sideways. But in 2018 and 2019, the story was all about valuation multiples – profits drifted sideways while the multiple plunged in 2018, and then symmetrically surged in 2019 (Chart I-2 and Chart I-3). Chart I-2Decomposing Stock Market Performance... Chart I-3...Into Valuation And Profits The cause of the stock market multiple contraction and re-expansion was the dramatic swing in bond yields. This is hardly surprising given that the prospective return on bonds drives the prospective return on competing long-duration assets, like equities and real-estate. Higher bond yields require a higher prospective return on equities, meaning a lower valuation multiple, while lower bond yields require a higher valuation multiple. In driving the swing in bond yields, the principal player was the Federal Reserve. Again, this is hardly surprising given that the ECB and BoJ are stuck on the side lines with monetary policy already locked at ‘maximum accommodative’, while the Fed can still move the lever in both directions. The cause of the stock market multiple contraction and re-expansion was the dramatic swing in bond yields. Through 2018-2019, the 10-year T-bond yield took a round trip from around 2 percent to 3.3 percent and then down again to around 2 percent where it stands today. This explains the mirror-image round trip in the stock market’s multiple: from 16 down to 13 and then back up again to 16 where it stands today (Chart I-4). Chart I-4The Round Trip In The T-Bond Yield Explains The Round Trip In The Stock Market's Valuation Admittedly, the Fed’s dramatic pivot was influenced by the trade war, and the perceived threat to global growth. But two other considerations loomed large: the persistent undershoot of inflation versus its 2 percent target; and the fragility of risk-asset valuations – and thereby financial conditions – to higher bond yields. Bear in mind that the value of global risk-assets at over $400 trillion now dwarfs the $80 trillion global economy by a factor of five to one. So the main danger is not that economic imbalances and fragilities will drag down the financial markets; the main danger is that financial market imbalances and fragilities will drag down the economy – as we painfully felt in 2000, 2007, and 2011. The Valuation And Growth Outlook In 2020 The two key investment questions for 2020 are: What will happen to bond yields, and what will happen to stock market profits? Starting with bond yields, most of the major central banks are, to repeat, out of play. Leaving the Fed as the principal player. But at the last press conference, Jay Powell, made it crystal clear that the Fed is also out of play for the time being, at least when it comes to raising rates. “We've just touched 2 percent core inflation, and then we've fallen back. So, I think we would need to see a really significant move up in inflation that's persistent before we even consider raising rates to address inflation concerns.” Reinforcing this, Powell also hinted at introducing a potential ‘tolerance band’ around the 2 percent inflation target – perhaps 1.5-2.5 percent – before the central bank would need to react. “We're also, as part of our review, looking at potential innovations… changes to the framework that would be more supportive of achieving inflation on a symmetric 2 percent basis over time… these changes to monetary policy frameworks don't happen really quickly (but)… I think we'll wrap it up around the middle of next year. I've some confidence in that.” What about profits – could 2020 be a repeat of the 2017 stellar growth story? No, there are two reasons why it will be very difficult to repeat the 2017 story on profits. The two reasons come from the two components of profits: sales and profit margins. Unlike in 2017, global sales will not start 2020 at the very depressed levels from which they can play a very strong catch-up. The first reason is that, unlike in 2017, global sales will not start 2020 at the very depressed levels from which they can play a very strong catch-up (Chart I-5). Significantly, the recession in global sales through 2015-16 was comparable to that suffered in 2008-09. The 2015-16 recession just hasn’t been well documented because it was essentially an emerging markets recession rather than the developed market recession of 2008-09. Chart I-5Global Sales Are Not Depressed The second reason is that today’s profit margins are still close to their structural and cyclical peak; whereas at the start of 2017, they were at a cyclical low (Chart I-6). Chart I-6Profit Margins Are Elevated Hence, the two components of profits – sales and profit margins – will start 2020 at elevated levels. The upshot is that profits can grow in 2020, but the growth will be pedestrian at best. Let’s summarise some of the key investment messages for 2020. High quality bond yields that are near the lower bound of -1 percent cannot go much lower, but those yields in the region of 2 percent cannot go significantly higher. It follows that fixed-income investors should underweight zero and negative yielding bonds versus higher yielding bonds – for example, underweight Swiss bonds versus US T-bonds. In a negative growth shock, T-bonds can still offer substantial capital gains but Swiss bonds cannot. For currencies, it is the opposite message. Favour lower yielding currencies because the central bank loses the ability to depress its own currency. For 2020, our preferred expression of this is long SEK/USD. Stock markets are set to produce low single digit returns. This is uninspiring, but in a world of low prospective returns from all major asset-classes, favour stocks over bonds and cash. This is especially true in those regions and countries where bond yields are zero or negative – specifically, Germany, Switzerland, and Sweden. Today’s profit margins are still close to their structural and cyclical peak The biggest risk to this view is if the global bond yield were to rise towards 2.5 percent exposing the fragility of the risk-asset edifice to higher bond yields. To repeat, the value of global risk-assets, at over $400 trillion, dwarfs the $80 trillion global economy. So the biggest risk comes from the valuation of global financial markets, it does not come from the global economy. More About Price To Sales Having completed our 20 paragraphs on 2020, we would like to follow up on the analysis in last week’s report: Are European Stocks Attractive? To recap, we found that price to sales is the stock market valuation metric that has the best predictive power for prospective returns – because unlike other metrics such as assets, profits, and cash flow, sales are quantifiable, unambiguous, and undistorted by profit margins. In last week’s report our prospective return forecasts were based on price to sales data sourced from Thomson Reuters. To which, several clients asked if the analysis would be the same using the price to sales data sourced from MSCI (Chart I-7). The answer is broadly yes. Chart I-8-Chart I-10 illustrate that: Chart I-7Despite The US, Germany, And Japan Trading On Different Valuations... Chart I-8...The Prospective Return From The US Is Low Single Digit... Chart I-9...The Prospective Return From Germany Is Low Single Digit... Chart I-10...The Prospective Return From Japan Is Low Single Digit... First, despite vastly different stock market valuations in Germany, Japan, and the US, the implied prospective 10-year annualised returns are almost identical. Second, the implied prospective returns from the MSCI calculated price to sales are slightly lower than from the Thomson Reuters data, because current MSCI valuations are closer to the dot com bubble peak. Third, this just reinforces the point that stock market valuations are very fragile to higher bond yields, as already discussed in our preceding 20 paragraphs on 2020. Fractal Trading System* This week we note that the strong outperformance of the Irish stock market is vulnerable to a correction based on its broken 65-day fractal structure. Accordingly, this week’s recommended trade is short Ireland (ISEQ 20) versus Europe (Stoxx Europe 600). Set the profit target and symmetrical stop-loss at 4 percent. In other trades, we are pleased to report that long gold versus nickel achieved its 11 percent profit target and is now closed. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment’s fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com. Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations
Highlights All the steps in the earnings dance are well known: Company management teams guide Wall Street analysts to lower their expectations in the weeks leading up to the beginning of earnings season, and their companies’ results then comfortably clear the lowered bar. Given the lack of true suspense, the S&P 500 largely ignores quarterly results: In the near term, moves in the S&P 500 have little to no relationship with either earnings growth or the magnitude of earnings beats. Over time, however, index prices and earnings move together: If earnings multiples mean-revert, earnings and prices have to converge over the long run. The equity bull market isn’t finished yet: The monetary policy backdrop will support earnings growth well into 2021, though it will not promote multiple expansion for much more than a year. Feature Chart 1We've Seen This Movie Before Taking a turn chairing BCA’s daily meeting last week, we duly updated our colleagues on the progress of earnings season. At the time, over 75% of the S&P 500’s constituents had reported, and the index was on its way to surpassing consensus analyst expectations by a few percentage points. We then showed charts tracking the course of expectations across each of this year’s three quarters to show that the “surprise” wasn’t actually very surprising (Chart 1). We included the charts to add a bit of levity, but a fellow strategist asked an incisive question: If earnings season follows the same pattern every quarter, why pay attention to it at all? Earnings season surely has its elements of Kabuki theater, but earnings are the fundamental basis for purchasing an ownership stake in a company. A share of stock is a claim on a company’s aggregate future earnings. To the extent that quarterly earnings reports provide a window into the trajectory of a company’s future earnings path, they contain relevant information about the fair value of its shares. Quarterly earnings offer more insight at the individual stock level than at the index level, as individual stocks are subject to idiosyncratic factors, while index earnings tend to reflect overall economic performance, and we therefore view them as a check on the other real-time indicators we examine to gauge the health of the economy. A review of how S&P 500 prices interact with S&P 500 earnings suggests that earnings have little to no impact on near-term index performance. They do move together in the long term, though, as they must if earnings multiples are a mean-reverting series. In the near term, when multiples are oscillating, anticipating stock market moves is a function of anticipating earnings growth and swings in multiples, which move independently of one another. The fed funds rate cycle has historically provided a good high-level guide to earnings and multiples trends. S&P 500 Performance During Earnings Season To test the S&P 500’s sensitivity to earnings surprises, we dug through weekly earnings updates going back to the beginning of 2012 (4Q11 earnings season) to compare expected index earnings per share (EPS) with reported index EPS.1 I/B/E/S has long been recognized as the earnings-estimates authority, so we use its estimates in conjunction with its compilation of reported earnings to ensure our analysis really is apples-for-apples.2 We track S&P 500 performance in three-month segments, beginning with the Monday following the second Friday of the new quarter, since that is the week that the banks typically get earnings season rolling. Earnings beats are stable and predictable, but the S&P 500's reaction to them is anything but. The empirical record over the last 31 quarters supports our colleague’s intuition. Over the 13 weeks following the major banks’ releases, S&P 500 performance exhibits no consistent link with earnings surprises (Chart 2). The best-fit line through a simple scatterplot shows that the relationship, such as it is, has been inverse and weak (Chart 3). The link with the year-over-year change in S&P 500 earnings is even weaker (Charts 4 and 5). Chart 2Earnings Surprises Don't Move The S&P 500 … Chart 3… Which Is Slightly Negatively Correlated With Them Chart 4Earnings Growth Doesn't Move The S&P 500 … Chart 5… Which Has No Short-Term Relationship With It Earnings data support our colleague’s contention that earnings season, at least as it relates to expectations, is something of a charade. Companies, which heavily influence analyst estimates with their guidance, have beaten expectations every quarter for at least eight years. As Charts 2 and 3 show, earnings beat expectations by an average of 3.7%, nearly the midpoint of the 1-6% range. The S&P 500 shouldn’t be expected to react to “surprises” that are more or less pre-ordained. Bottom Line: Earnings season has no observable impact on the S&P 500. Earnings attract a lot of attention, but they do not influence index-level performance in the near term. The S&P 500 And Earnings Over Longer Periods Anything can happen over short periods, but stock prices have to track earnings over the long term. If the idea that an ownership share represents a proportional stake in company earnings is too abstract, consider the equity equation. Equity prices, P, can be viewed as the product of earnings, E, and the multiple investors are willing to pay for each dollar of earnings, P/E. P = E * (P/E) The market P/E ratio is subject to mean reversion, making changes in earnings the key long-term driver of S&P 500 performance. Since 1966, the S&P 500 index (Chart 6, top panel) has appreciated at the same rate as its trailing four-quarter operating earnings (Chart 6, middle panel), given that its trailing multiple is not far from where it started (Chart 6, bottom panel). Growth in forward earnings expectations (Chart 7, middle panel) has lagged S&P 500 growth (Chart 7, top panel) since expectations data began to be compiled in 1979 because the forward multiple has more than doubled from late ‘70s trough levels (Chart 7, bottom panel). In any extended period not bookended by an outlier multiple, however, one should expect S&P 500 appreciation to track earnings estimate growth. Chart 6S&P 500 Earnings And Prices Will Converge Over Time ... Chart 7... As Long As The Starting Or Ending Multiple Isn't An Outlier Bottom Line: Stock price gains and earnings growth will converge over the long run as long as the earnings multiple mean-reverts. Earnings do matter in the long run. Where Do We Go From Here? There are several earnings growth models within BCA. Like all regression models, they often work well in stretches, but are susceptible to unanticipated inflections and changes in correlations. Since the crisis, the difference between year-over-year growth in industrial production and year-over-year growth in the money supply has aligned closely with earnings growth (Chart 8). If we (and global equity markets) are correct in sniffing out a bottoming in global manufacturing activity, and loan growth is unlikely to accelerate much as banks are pulling in their horns in commercial real estate and selected consumer categories, earnings growth could pull out of its funk. Chart 8Earnings Growth Will Revive Once Global Manufacturing Pressure Abates We have found that earnings growth and multiple re-rating or de-rating is reliably influenced by the monetary policy backdrop. While the level of the fed funds rate goes a long way to explaining overall index moves, earnings growth and multiple expansion/compression are a function of its direction. Broadly, forward estimates grow at a rapid rate when the Fed is hiking rates (the economy is expanding) and slump when it’s cutting them (the economy needs a hand). Forward multiples are the mirror image of earnings estimates, contracting when the Fed is hiking and expanding at a robust clip when the Fed is cutting. Earnings grow at a rapid clip when the Fed is leaning against a too-strong economy, but they slump when the Fed is trying to nurse it back to health. Viewed through the lens of the fed funds rate cycle (Figure 1), policy had been in Phase I from December 2015, when the Fed began hiking rates, until the end of July, when the Fed began cutting, transitioning into Phase IV. Phase IV has been characterized by solid multiple expansion and, ex-2008-9, decent earnings growth. It will remain in force until the Fed returns to hiking rates, which we do not expect until the second half of 2020 at the earliest. Once the Fed does resume hiking, it will likely take some time for it to raise the fed funds rate above its equilibrium level (Phase II). Figure 1The Fed Funds Rate Cycle Our base case is that the Fed will not turn restrictive until 2021. Easy monetary policy is a tailwind for earnings growth, which remains strong in Phase II, so we expect that earnings growth will shake loose of 2019’s doldrums across the next two years. Stocks should benefit from re-rating until the Fed resumes hiking rates (Phase I), cutting off multiple expansion. They will de-rate once monetary policy becomes restrictive (Phase II), as it must once the Fed perceives a need to cool the economy. The bottom line is that the monetary policy backdrop should be earnings-friendly well into 2021, even if multiple expansion isn’t likely to persist beyond the next nine to twelve months. Investment Implications Investors should not look to quarterly earnings reports to inform asset allocation decisions. Quarterly releases may be telling for individual companies’ longer-run profit potential, but they do not shed much light on the S&P 500’s future earnings. The long-run index earnings profile is much more likely to be influenced by broad themes than real-time data points. We devote our focus to the cyclical forces affecting asset-class-level returns, and find that the monetary policy cycle offers useful insight into future moves in earnings and multiples. The Fed's dovish pivot will help keep the expansion going, ... That insight is favorable for equities, and for spread product as well. We are in the latter stages of both the business cycle and the credit cycle, but new injections of monetary accommodation and the postponement of the shift to restrictive monetary policy settings will extend the longevity of the expansion and the period over which credit generates positive excess returns. Investors have different objectives and risk tolerances, but we think all of them should remain at least equal weight equities in balanced portfolios, and overweight spread product (and underweight Treasuries) within fixed-income sleeves. It is too soon to de-risk investment portfolios. Doug Peta, CFA Chief U.S. Investment Strategist dougp@bcaresearch.com Footnotes 1 All data cited in this section comes from Refinitiv’s (formerly Thomson Reuters’) This Week in Earnings publication. 2 Earnings estimates compiled by other vendors may differ from I/B/E/S estimates, and other measures of reported earnings, like Standard & Poor’s, regularly diverge from I/B/E/S’.
Highlights The banks got the current earnings season off to a good start, … : Lending growth may be running in place, and net interest margins are under pressure, but positive operating leverage helped the banks beat expectations, and they are returning gobs of cash to their shareholders. … are quite constructive about the economy, … : The big banks’ CFOs and CEOs were uniformly bullish about the U.S. economy based on their perceptions of household and corporate health. … expect stellar credit performance to continue for the foreseeable future, … : Net charge-off and non-performing loan ratios are near all-time lows and the banks don’t see them rising any time soon. … and appear to be willing to extend loans in all categories except commercial real estate: Every bank sees unattractive competition in commercial real estate lending and plans to continue shrinking its CRE loan book. Nothing To See Here Two-fifths of the companies in the S&P 500 have now reported their quarterly earnings, and after this week the share will be two-thirds. At the aggregate level, it appears as if investors’ worst fears will not be realized, just as they weren’t in the first two quarters of the year. 2018’s greater than 20% year-on-year growth, powered by the sharp cut in the top corporate income tax rate, has rolled off, but earnings have yet to contract. They were projected to fall by a little over 3% at the beginning of this reporting season, but repeated practice has allowed corporate managements to hone their underpromise-and-overdeliver skills to a fine point, and we won’t be surprised if they avert an outright contraction. Chart 1Profit Margins Are Being Squeezed, ... Chart 2... But Neither Growing Compensation, ... Earnings growth has been stagnant this year (Chart 1, bottom panel), though revenues have grown a little faster than nominal GDP (Chart 1, top panel), with which they should converge over time. Profit margins have finally come under pressure, though it’s not exactly clear why. Employee compensation is businesses’ biggest expense by far, and while it has risen from its lows, its growth decelerated last quarter (Chart 2). Dollar strength is a headwind for U.S.-based multinationals, but the dollar only really moved last quarter, after ending the first half where it started the year (Chart 3). Dollar gains weigh on revenues just as surely as they do on profits, though we would not be at all surprised if the share of non-dollar expenses is a good bit smaller than the widely quoted 33-40% estimate of S&P 500 constituents’ foreign sales. Chart 3... Nor A Stronger Dollar Is A Clear-Cut Culprit Rate cuts have sparked a wave of mortgage refinancings, shifting wealth from mortgage investors to homeowners, who are more likely to spend it. Easier monetary conditions should help grease the skids for future earnings growth, both in the U.S. and abroad, and we expect the Fed will cut the fed funds rate by another 25 basis points when it meets this week. We have sympathy for the argument that since interest rates were not a meaningful constraint on growth, cutting them is not likely to provide much of a catalyst. Falling rates have provoked a wave of mortgage refinancings (Chart 4), however, so even if they don’t drive a big lending increase, they are already on their way to putting more money in the pockets of homeowners. Lower rates also reduce the risk of default by lowering debt-service costs for adjustable-rate borrowers, and by encouraging investors who need income to venture further out the risk curve, providing ample capital for borrowers seeking to extend their maturing obligations. Chart 4Putting More Money In Homeowners' Pockets Follow The Money Chart 5Bank Stocks Are Probing Resistance For two years, beginning in 2014, we reviewed the biggest banks’ earnings calls every quarter. The goal was to observe the give and take between bank management and sell-side analysts to gain some insight into the lending market and where it might be headed. We specifically sought information about banks’ willingness to lend, consumers’ and businesses’ appetite for credit, borrower performance, and the banks’ bottom-up perspective on the economy. We were also trying to glean insight into mortgage lending and what it might imply for residential investment. Studying the banks is a natural pursuit for a firm that was founded upon the insight that following money flows through the banking system would provide us with a window into the future direction of the economy and financial markets, and we return to it today. Our analysis is not meant to evaluate the banks’ own investment potential, though we note that they are testing resistance once again (Chart 5), and our Global Investment Strategy and U.S. Equity Strategy services both recommend overweighting them. This round of calls found bank management teams eager to ramp up their distributions to shareholders and optimistic about their ability to deploy technology to drive further efficiency gains. Big Banks Beige Book As a group, the banks were constructive on the economy. Despite widespread recession concerns, they do not see evidence of a looming slowdown from their interactions with consumers and businesses. Overall loan growth has remained around 5% over the last year and a half (Chart 6), while corporate and industrial (C&I) loan growth has ground to zero over the last thirteen weeks (Chart 7). The CEOs and CFOs do not see the C&I slump as the beginning of a worrisome trend, though, and global corporate bond issuance hit an all-time high in September, led by sizable issues from mega-cap U.S. companies. Businesses seeking credit are having no trouble getting it, though all the banks expressed an intention to continue cutting back their exposure to commercial real estate (CRE) loans. Chart 6Bank Lending Is Supporting Activity Without Risking Overheating Chart 7Lending Momentum Has Slowed, But It's Okay Another commercial real estate issue emerged across the calls: several of the biggest banks are consolidating their branch footprints. Prompted by questioning from one analyst, they touted branch closures as a way to enhance efficiency. We do not know if a reduction in bank demand for branch space would have an observable effect on demand for retail space across the country, but it certainly would in Manhattan. It seems possible that branch closures could pressure some retail lessors’ profitability, and thereby act as a drag on CRE whole-loan and CMBS performance at the margin. The Economy [C]onsumer spend and … confidence continue to be strong. I think business activity continues to be strong. I think it’s moderated somewhat because of … trade policy, but generally, I think the economy is solid. (Dolan, USB CFO) I think it’s fair to say that perhaps marginal investment is being impacted by trade fatigue in terms of the uncertainty, but … [there’s] still growth. … [T]he consumer is incredibly strong, … spending is strong, sentiment is strong, … credit is good. [I]t is true that [the recent ISM manufacturing and non-manufacturing surveys] were disappointing[,] so [there are] cautionary signs, but credit remains very good and there is still very healthy business activity. (Piepszak, JPM CFO) In general, our commercial customers continue to see moderate demand and no widespread issues related to trade uncertainty and interest rate changes. … [W]hile our customers are cautious, the most common concern they identify is their ability to hire enough qualified workers. (Shrewsberry, WFC CFO) Consumer payments up 6% year-to-date … [and 6% year-over-year 3Q growth in both our small business segment and total commercial loans] are tangible examples that the U.S. economy is still in solid shape, despite the worries and concerns about trade wars, capital investment slowdowns or other global macro conditions. (Moynihan, BAC CEO) Borrower Performance [W]e’ve had growth in the United States for the better part of 10 years [a]nd … credit is extraordinarily good. … [C]onsumer credit, commercial credit, wholesale is extraordinarily good, it can only get worse if you have a [turn in the] cycle. [Our guidance relates to expected performance across a full cycle.] We’re at the over-earning part of the cycle [beating the through-the-cycle expectation] in credit today, and [at] one point we’ll be at the under-earning part [pulling the full result down to our expectation]. (Dimon, JPM CEO) Our net charge-off rate remains near historic lows at 27 basis points (Chart 8). (Shrewsberry, WFC) Chart 8C&I Charge-Off Rates Are Near Their Historic Lows Credit quality remains stable, and we are not seeing any early indicators in our portfolio that cause us concern. (Cecere, USB CEO) Banks see no broad credit warning signs, but they're perfectly happy to let non-bank lenders take some commercial real estate share at this point of the cycle. We closely monitor our commercial portfolio for signs of weakness and credit quality indicators remain strong. (Shrewsberry, WFC) Lender Willingness [W]e are mindful that at some point, the industry will experience a credit downturn, and we remain disciplined in terms of origination quality and our long-term strategy of remaining within our defined credit box regardless of the competitive environment. (Cecere, USB) [Commercial] real estate banking [declined] as we remain selective, given where we are in the cycle. (Piepszak, JPM) [Commercial real estate lending] is one market where there’s late cycle behavior, there’s lots of non-bank competitors, … more than bank competitors. And so we really have to pick our spots in order to maintain our risk/reward, credit and pricing in loan terms quality. … I wouldn’t look for it to grow meaningfully until the cycle turns and our best customers have really interesting opportunities to put their own capital to work. (Shrewsberry, WFC) [Our declining commercial real estate lending is] really a function of [competition] that we’re not comfortable with. (Cecere, USB) Banks’ Real Estate Demand [C]ustomer behaviors are changing. The amount of transaction activity that’s happening in the branches is significantly less[.] In fact, … roughly 70, 80% of it goes through the digital channel today. So that gives us the opportunity to really reconfigure the branch network, both in terms of size and numbers[.] I think those trends are going to continue … , and … we may accelerate or increase some of [our right-sizing] activity[.] (Dolan, USB) Teller and ATM transactions declined 6% from a year ago, reflecting continued customer migration to digital channels. We’ve consolidated 130 branches in the first nine months of this year, including 52 branches in the third quarter. (Shrewsberry, WFC) [D]o we continue to work on real estate configurations that were down 50 million square feet from the start of 2010[?] [C]an we push [the occupancy rate] up, can we densify the space[?] (Moynihan, BAC) Investment Implications While rereading the April 2014 U.S. Investment Strategy that reviewed the big banks’ 1Q14 earnings calls, we were struck by how similar the picture is today. Back then, we described the central challenge for investors as choosing between mushy fundamentals and generous monetary policy that might be expected to inspire a valuation overshoot. As we do now, we anticipated that activity would soon pick up, providing markets with a fundamental boost, but we also had the sense that “policy settings are such that no much more than the status quo may be required to keep the party going.” We reiterated our equity overweight and our preference for spread product over Treasuries. Between inflection points, investing is an exercise in trend following, and there's no reason to believe that the monetary policy trend is about to change without clear advance notice. Although we are congenitally optimistic about our species and our country, we are not perma-bulls. We simply recognize that, between inflection points, investing is an exercise in trend following, no matter how uncomfortable it may make an investor to leave the portfolio dials alone for a while. As long as the monetary policy backdrop remains extremely accommodative across all of the major developed economies, and central banks are set to add even more accommodation before they start removing it, the bullish trend will remain in place. The prospective real returns of cash and highly-rated sovereign bonds are likely to remain negative for a while against that backdrop, encouraging investors to direct their marginal investment dollar to risk assets as long as a fundamental reversal is not imminent. We think a fundamental inflection is at least two years away, and therefore continue to believe that it is too early to de-risk investment portfolios. We reiterate our recommendation that investors remain at least equal weight equities in balanced portfolios, and at least equal weight spread product within their fixed-income allocations. Doug Peta, CFA Chief U.S. Investment Strategist dougp@bcaresearch.com
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先週合意された暫定的な「フェーズ1」貿易協定は、米中貿易戦争におけるデタントに向けた重要な一歩を示しています。
ブレグジット交渉の今後にかかわらず、ハード・ブレグジットは回避される見込みです。ポンドをロングで保有し続けてください。
米国の企業業績の伸びは第3四半期に横ばいとなる可能性が高く、ボトムアップの予想にある前年比減少とは対照的です。
世界成長が年末までに再加速すれば、企業業績の伸びは回復するはずです。
世界成長の強まりは米ドルに下押し圧力をかけるでしょう。
12か月の期間では、債券に対してグローバル株式をオーバーウェイトのまま維持してください。
景気循環株はディフェンシブ株をアウトパフォームし始めるはずです。金融セクターはついに日の目を見るでしょう。
好ましい追い風
2週間前に公表した第4四半期ストラテジー・アウトルックでは、グローバル株式が「見せて」フェーズに入ったと主張しました。つまり、株価指数が上昇するには、貿易戦争のエスカレーションの緩和と世界成長の回復を示す具体的な証拠が必要だという意味です。1
先週金曜、貿易面でいくつかの好材料がありました。2500億ドル相当の中国からの輸入品に対し10月15日に25％から30％へ引き上げる予定だった関税の実施を見送ることと引き換えに、中国は年間で400～500億ドル分の米国農産物を購入し、米国の金融サービス企業への市場アクセスを改善し、為替管理の透明性を高めることに合意しました。
確かに、やるべきことはまだ多く残っています。協定文はまだ最終化されていません。両国は、11月16–17日のチリ・サンティアゴでのAPECサミットまでに合意をまとめることを目指しています。しかし、どのような執行・解決メカニズムが協定に盛り込まれるかなど多くの重要課題が未解決のままであることを考えると、さらに遅延したり、交渉が決裂したりする可能性もあります。
先週の暫定合意は、知的財産保護の扱いという厄介な問題を「フェーズ2」に先送りする形にもなっています。「フェーズ1」がまとまり次第、間もなく「フェーズ2」が始まる予定です。
独立かつ超党派の米国知的財産の窃盗に関する委員会によれば、米国の生産者は知的財産の窃盗により年間で約$225～$600 billionの損失を被っているとされています。2 中国はしばしば最悪の加害国の一つと見なされてきました。
知的財産問題の重要性を考えれば、約1600億ドル相当の中国からの輸入に対して15％の関税が12月15日に導入されないようにするには、実質的な進展が必要となるでしょう。
トランプは合意を望んでいる
多くの障害が残るものの、先週の展開は18か月に及ぶ貿易戦争のデタントの見込みを大きく高めました。自称「マスター交渉人」であるトランプ大統領は、交渉を「ラブフェスト」と表現し、この貿易協定は「我が偉大なる愛国的農家のために結ばれたこれまでで最大かつ最高の取引だ」と呼び、最終合意が達成されることに「ほとんど疑いはない」と述べて自らの信頼性を賭けています。NAFTAの後継であるUSMCAと同様に、トランプは交渉を自らの功績として宣伝するマーケティングモードに入る可能性が高く、米国民のために交渉した「驚くべき」新協定を大々的に宣伝するでしょう。
政治的観点から見ると、これは非常に理にかなっています。正否は別として、トランプ大統領は有権者から経済運営について他のどの分野よりも高い評価を受けています（チャート 1）。長引く貿易戦争は米国経済を弱体化させ、トランプの再選の見通しを損なうことになります。
チャート 1
トランプは経済運営について比較的高評価を得ているが、他はそれほどではない
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チャート 2
中国企業は関税の大部分を負担していない
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トランプの主張に反して、証拠は明確に米国の消費者が関税の大部分を負担していることを示唆しています。チャート 2は、対中輸入品に対する関税率が上昇する一方で、米国の輸入価格はほとんど下がっていないことを示しています。最近の関税の多くが米国や第三国に競合相手がほとんどいない中国製品に焦点を当てている以上、中国の生産者が関税コストを転嫁する能力はさらに高まります。
もし発表されたすべての関税引き上げが実施されれば、対中輸入品の実効関税率は8月下旬時点の約15％から12月には最大約25％にまで上昇することになります（チャート 3）。そのような関税率は、米国の可処分所得を1000億ドル以上減少させ、2017年の減税によるほとんどの恩恵を消し去ることになります。トランプは貿易戦争をそこまで進行させるわけにはいきません。
チャート 3
度重なる関税引き上げが積み重なり始めている
相次ぐ関税が積み重なり始めている
相次ぐ関税が積み重なり始めている
中国は強硬策に出るか？
貿易戦争を有利に解決する上でのリスクの一つは、中国側がトランプを「合意に飢えている」と見なし、交渉で強硬姿勢をとる可能性があることです。このリスクは無視できませんが、我々は次の三つの理由でそれを過度に重視しません。
第一に、貿易戦争の期間、中国の輸出業者はある程度の価格決定力を維持してきたとしても、貿易量は依然として悪化しており、9月の対米輸出は前年同月比でほぼ22％減少しています。
第二に、ZTEに対する強力な制裁が示したように、中国は依然として米国の技術に大きく依存しています。これがトランプに交渉上の大きなレバレッジを与えています。
チャート 4
誰が2020年の民主党指名を勝ち取るか？
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第三に、トランプ自身がよく言うように、中国は彼の第1期目の任期中に彼と交渉する方が、第2期目になってから交渉するよりも容易だと考えるでしょう。数か月前、ジョー・バイデンが世論調査で高支持率だったときにはトランプの再選を望まない方が中国にとって理にかなっていたかもしれませんが、エリザベス・ウォーレンが民主党指名を獲得する有力候補として浮上したことで、その希望は消えました（チャート 4）。数週間前に述べたように、中国はウォーレンが貿易問題でトランプよりも手ごわくないとは考えないでしょう。3
これらすべてを総合すると、中国もトランプ同様、今後数週間で貿易緊張を和らげる方法を模索するだろうと示唆しています。
ブレグジットの突破口か？
記事執筆時点で、ブレグジット合意の見通しは明るくなっています。詳細はまだ公表されていませんが、提案された合意は北アイルランドを事実上、欧州単一市場の一部でありながら同時に英国の一部でもあるという量子的な重ね合わせ状態に置くことになります。これは北アイルランドを英国の政治的管轄下に置きつつ、EUの規制基準と整合させ続けることで実現されます。
交渉が破綻する可能性は依然としてあります。ジョンソン首相が「素晴らしい新協定を取り付けた」と確約したにもかかわらず、保守党の連立相手である北アイルランドの民主統一党は依然として協定への支持を留保しています。労働党のジェレミー・コービン党首もこれを拒否し、テリーザ・メイが当初提案した協定よりもさらに悪いと述べています。
今後数日に何が起きようとも、我々はハード・ブレグジットは回避されると引き続き考えています。ブレグジット問題を通じて、英国の支配階級の中に無協議離脱を支持する十分な政治的支持は存在しないと我々は主張してきました。世論調査が示すように、再度国民投票が行われればEU残留を選ぶ有権者の割合が増えていることが明らかになるにつれ、その確信はさらに強まっています（チャート 5）。
我々は2017年8月3日以来、ユーロに対してポンドをロングしています。このトレードはこの期間で6.6％上昇しました。投資家はこのポジションを維持すべきです。実質金利差に基づけば、GBP/EURは現在の1.16ではなく1.30付近で取引されるべきであると考えられます（チャート 6）。ハード・ブレグジットリスクがさらに後退すれば、クロスは公正価値に向かうと予想します。
チャート 5
ブレグジット不安：後悔の事例
ブレグジット不安：ブレモースの場合
ブレグジット不安：ブレモースの場合
チャート 6
ポンドには大きな上値余地がある
ポンドの大幅な上昇余地
ポンドの大幅な上昇余地
世界成長見通しは改善
チャート 7
成長減速はソフトデータでより顕著だった
景気の減速はソフト指標でより顕著になっている
景気の減速はソフト指標でより顕著になっている
チャート 8
ISMの低迷の中で製造業生産は反発している
製造業の生産高がISM指数の低迷の中で反発
製造業の生産高がISM指数の低迷の中で反発
貿易戦争のデタントとブレグジット問題の解決は世界成長を下支えするはずです。経済データの弱さは、事業調査のような「ソフト」指標でより明確に現れており、工業生産などの「ハード」指標ほど顕著ではありません（チャート 7）。特に、ISM製造業指数が低迷する中でも、過去3か月間で米国の製造業生産は安定しています（チャート 8）。センチメントが回復すれば、ソフトデータも改善するでしょう。
世界の金融環境は、主に多くの中央銀行によるハト派転換のおかげで過去5か月で大幅に緩和されました（チャート 9）。政策金利を引き下げた中央銀行の純数は、一般に6～9か月先行して世界の製造業PMIをリードします（チャート 10）。加えて、FRBが再び国債買入れを開始した決定はドル流動性を増やし、金融環境の更なる緩和に寄与するでしょう。
チャート 9
緩和された金融環境が世界成長を押し上げる
金融環境の緩和が世界経済の成長を後押しする
金融環境の緩和が世界経済の成長を後押しする
チャート 10
金融緩和の効果は間もなく実体経済に波及するはずだ
金融緩和の効果は間もなく経済に波及するはずだ。
金融緩和の効果は間もなく経済に波及するはずだ。
中国による景気刺激の強化も世界成長の再加速を後押しするはずです。中国のマネーおよびクレジットの伸びは9月に予想を上回りました。中国人民銀行は預金準備率を引き下げており、これがインターバンク金利の低下に寄与しています。残りの今年期間で中期貸出制度（MLF）への更なる利下げが予想されます。中国のクレジット成長の変化は世界成長を約9か月先行します（チャート 11）。
チャート 11
中国の信用拡大が世界成長の回復を支える
中国のクレジットは世界経済の成長回復を支えるはずだ
中国のクレジットは世界経済の成長回復を支えるはずだ
グローバル株式をオーバーウェイトのまま
APECサミットまでに「フェーズ1」貿易協定をまとめる道のりはでこぼこ道である可能性が高いものの、我々は12か月の投資期間において債券に対してグローバル株式をオーバーウェイトするという推奨を引き続き強調します。
世界成長が底打ちしているという証拠をもう少し確認でき次第、数週間以内に新興国（EM）および欧州株式の評価を引き上げる見込みです。
最終的に株式の軌道は業績の動向に依存します。米国の決算シーズンは今週始まりました。先週時点でFactSetがまとめたデータによれば、アナリストはS&P500のEPSが第3四半期に前年同期比で4.6％減少すると予想していました。ただし、2015年以降、EPS成長は概ね予想を約4ポイント上回ってきたことを念頭に置いてください（チャート 12）。したがって、妥当な見方は、米国の業績は今四半期横ばいとなり、低い期待値のハードルをクリアするというものです。
チャート 12
実際のEPSは概ね予想を上回っている
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チャート 13
利益と名目GDP成長は同じ動きをする傾向がある
収益と名目GDP成長率は歩調を合わせて動く傾向がある
収益と名目GDP成長率は歩調を合わせて動く傾向がある
これまでに決算を発表した63社のS&P500構成銘柄のうち83％が予想を上回っており、これは歴史的平均の64％を上回っています。これにより現在の第3四半期の見積りは悲観的すぎるという見方が支持されます。
先を見れば、名目GDP成長が加速するにつれて業績成長は回復するはずです（チャート 13）。
世界成長が加速すると、新興国（EM）と欧州株式は一般にグローバルベンチマークをアウトパフォームする傾向があります（チャート 14）。これはそれらの株式市場がより景気循環的であるためです。加えて、ドルは逆循環的通貨として、高成長環境では弱含む傾向があります。ドル安は景気循環株に対して相対的に大きな恩恵をもたらします（チャート 15）。
チャート 14
新興国およびユーロ圏の株式は世界成長が改善すると通常アウトパフォームする
世界経済の成長が改善すると、新興国株式とユーロ圏株式は通常アウトパフォームする
世界経済の成長が改善すると、新興国株式とユーロ圏株式は通常アウトパフォームする
チャート 15
ドルが弱含めば景気循環株がアウトパフォームする
ドル安になれば景気循環株がアウトパフォームする
ドル安になれば景気循環株がアウトパフォームする
我々は金融株を景気循環セクターの定義に含めます。世界成長が改善すると、長期国債利回りは限界的に上昇します。中央銀行が急いで利上げする状況にはないため、イールドカーブはスティープ化するでしょう。これが銀行の利益と株価を押し上げます（チャート 16）。
景気循環株は現在ディフェンシブ株と比べてかなり割安です（チャート 17）。同様に、非米国株式は地域間のセクター構成の違いを調整しても、米国株に比べてかなり割安です。米国株はフォワードEPS倍率で17.5倍で取引されているのに対し、国際株式はより魅力的な13.7倍のフォワードPEで取引されています。より高い利益利回りとより低い海外金利の組み合わせは、米国外の株式リスクプレミアムが概ね2パーセントポイント高いことを示唆しています（チャート 18）。
チャート 16
利回り曲線の急勾配化は金融株に恩恵をもたらす
より急勾配なイールドカーブは金融セクターに恩恵をもたらす
より急勾配なイールドカーブは金融セクターに恩恵をもたらす
チャート 17
景気循環株はディフェンシブ株より魅力的だ
景気循環株はディフェンシブ株より魅力的だ
景気循環株はディフェンシブ株より魅力的だ
チャート 18
株式リスクプレミアムはかなり高く、特に米国外で顕著だ
株式リスクプレミアムはかなり高く、特に米国外で顕著です。
株式リスクプレミアムはかなり高く、特に米国外で顕著です。
世界成長が底打ちするという証拠をもう少し確認でき次第、我々は数週間以内に新興国および欧州株式の評価を引き上げる見込みです。
ピーター・ベレジン、 チーフ・グローバル・ストラテジスト グローバル・インベストメント・ストラテジー peterb@bcaresearch.com
脚注
1本文は、グローバル・インベストメント・ストラテジーの「第4四半期2019 ストラテジー・アウトルック：『見せて』市場」（2019年10月4日）を参照してください。
2 「Update to IP Commission Report: The Report of the Commission on the Theft of American Intellectual Property」（2017年）、The National Bureau of Asian Research。
3本文は、グローバル・インベストメント・ストラテジー週次レポートの「エリザベス・ウォーレンと市場」（2019年9月13日）を参照してください。
ストラテジー＆マーケット動向
マクロクォント・モデルと現在の主観的スコア
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戦略的推奨
クローズドトレード
Dear Client, Owing to BCA’s 40th Annual Investment Conference at the Grand Hyatt in New York City next week, there will be no report on Wednesday, September 25. We will return to our regular publication schedule on Wednesday, October 2. I look forward to meeting China Investment Strategy clients in person at our conference. Please do not hesitate to say hello. Best regards, Jing Sima China Strategist Highlights China’s economy should bottom as a result of the pickup in credit that occurred earlier this year, but the circumstances surrounding the ongoing slowdown are unprecedented in nature. This raises the risk that policymakers will have to do more in order to stabilize growth. Optimism surrounding recent Chinese policy announcements is misguided. For now, Chinese policymakers are not upping the pace of stimulus, which underscores the risk to our forecast that growth will soon stabilize. A more meaningful shot of reflation will occur in the coming few months if the economy slows further, but policymakers will be reactive rather than proactive. Barring a successful (even if temporary) trade deal, we expect more weakness in the RMB as a passive source of reflation to aid the economy. But currency devaluation is a double-edged sword, and cannot be counted on to single-handedly stabilize China’s economy. Over a 6-12 month time horizon, investors should continue to overweight Chinese stocks versus the global benchmark in currency hedged terms, but the risk of further underperformance over the near-term is high. Feature Chinese economic growth continues to weaken. The Caixin manufacturing PMI for August, along with the New Export Orders component of the manufacturing PMI released by China’s National Bureau of Statistics, registered small gains in August from July. However, any hopes pinned on this being an emerging sign of turnaround in the Chinese economy soon faded. A slew of August data showed continued sluggishness in exports, an even worse domestic-demand picture, and further deflation in ex-factory producer prices. Most importantly, we continue to witness “half-measured” stimulus. In explaining past and existing economic weakness, many investors point to the trade war with the U.S. However, Charts 1 and 2 serve as an important reminder that domestic weakness predates U.S. protectionism. The trade war tensions and tariffs are magnifying this weakness, but China’s slowdown is, at its core, policy driven. Chart 1Weakness In Chinese Economy Predates The Trade War... Chart 2…And Has Been A Byproduct Of Financial De-Risking Campaign Given this, investors should be more focused on identifying signs of a major reversal in policy. So far Chinese policymakers have been firmly holding their line in keeping credit growth somewhat in check. Policy-Induced Economic Stabilization: A Tough Forecast To Make Our baseline view is that the current scale of stimulus should be sufficient to stop economic growth from decelerating further. Two factors support our baseline view: The direct impact from tariffs on the Chinese economy is limited. Growth in China’s exports to the U.S. in 2019 is likely to be somewhere close to a 9% contraction, down from the 10.8% increase registered in 2018. Based on a simple calculation with all else being equal, this is likely to shave 1.6 percentage points off China’s total export growth and 0.3 percentage points off nominal GDP growth in 2019. This is not trivial, but arguably not devastating to China’s aggregate economy either. There is anecdotal evidence suggesting some Chinese exports have been re-routed to peripheral countries such as Vietnam and Taiwan in order to avoid the U.S. import tariffs on Chinese goods (Chart 3). This suggests that real growth in Chinese exports to the U.S. could be stronger than the current data suggests. Chart 3Exports Finding Alternative Routes? Chart 4Bottoming in the economy In Sight? Credit growth has picked up since the beginning of this year. Based on the historical relationship between China’s credit impulse (measured by the 12-month change in BCA’s adjusted total social financing as a percentage of nominal GDP) and domestic demand, the economy should bottom out at some point before the end of the year (Chart 4). Although, import growth, a key measure of China’s domestic demand, remains in deep contraction, some of its components that usually lead industrial activities are showing signs of improvement (Chart 5). Chart 5Early Signs of Improved Domestic Demand Chart 6Manufacturing Investment Growth In Contraction However, our level of confidence that the existing stimulus will be sufficient to stabilize economic growth is lower than it otherwise would be. This is due to the fact that the challenges facing the Chinese economy are unprecedented in nature. For one, the indirect impact of the trade war on China’s economy through business sentiment and manufacturing investment has yet to be fully revealed in the data. As Chart 6 shows, manufacturing investment is already deteriorating, particularly in export-intensive sectors. The ultimate impact on investment from the trade war is still uncertain, and can pose significant downside risks to the Chinese economy in the coming year. More importantly, as Chart 7 suggests, a weak credit impulse will at best lead to a very subdued economic recovery even if growth does indeed bottom. In terms of the link between policy and the economy, Chart 8 points out a key difference between the current slowdown and previous down cycles: Monetary conditions have been ultra-loose for more than a year, but current economic conditions remain on a downward trend – much more so than in the previous cycles. This huge gap and lag in economic response to monetary stance can only be explained by an impaired policy transmission mechanism. An expansionary monetary stance has not proportionally translated into credit expansion or economic recovery. This challenges the effectiveness and timeliness of future monetary loosening in terms of its ability to revive the Chinese economy. Chart 7Current Pace Of Credit Growth Will Lead To A Fragile Recovery, At Best Chart 8An Impaired Monetary Policy Transmission The scale and timing of the current stimulus measures have been “behind the curve.” Therefore, the historical relationship between China’s credit impulse and the turning points in the economy may not apply to the current cycle. Bottom Line: China’s economy should bottom as a result of the pickup in credit that occurred earlier this year, but the circumstances surrounding the ongoing slowdown are unprecedented in nature. This raises the risk that policymakers will have to do more in order to stabilize growth. An Unusually Prudent Policy Bias For some, the recent slew of announcements on upcoming stimulus qualified as a major shift in policy bias. Our analysis suggests otherwise. The bank reserve requirement ratio (RRR) cuts announced late in August have been among the most cited policy announcements, with the PBoC stating that the new cuts will release RMB 900 billion of fresh liquidity.1 In our view, this measure is more about maintaining liquidity in China’s large commercial banks than adding to it (on a net basis). Chart 9RRR Cuts May Not Be That Stimulative Chart 9 shows that, in previous episodes of meaningful RMB depreciation against the U.S. dollar, in order to prevent the RMB from falling at an undesirable pace, PBoC has had to intervene in the spot market by selling U.S. dollars. The selling of U.S. dollars in this round of RMB depreciation has been much more muted than in 2015-2016, but we suspect some intervention has taken place following each bout of escalation in the trade war. This has had a liquidity tightening effect on banks, as selling central bank foreign-exchange reserves reduces liquidity in the banking system. It is very likely that following the PBoC’s defense of the RMB in the last two months, the RRR cuts were a measure aimed at preventing a liquidity crunch ahead of the September tax season. If true, this hardly qualifies as net new stimulus for the economy. There were also two important announcements that came out of the September 5th State Council meeting: The entire 2019 quota for local government special project bonds must be issued by the end of September, and all money raised from the bonds must be disbursed to projects by the end of October. This too is not exactly “stimulative,” as over 90% of the 2019 local government special-project bond quota has already been issued. This leaves less than 10% of the quota outstanding, an 80% decline from what was issued last September. On a quarterly basis, special-bond issuance in the third quarter of 2019 will end up being 30% lower than the same period last year. It was also announced that, in order to meet the local needs for construction of key projects, part of 2020’s special bonds quota will be allocated in advance to ensure that the funds are available for use at the beginning of next year.2 While the announcement did not indicate how much in the way of special-purpose bonds local governments are allowed to frontload through the remainder of this year, we maintain our view that this is not a policy shift towards materially larger stimulus than we have seen so far this year: Without an additional quota, local government special-purpose bond issuance would essentially fall to zero in the fourth quarter as the 2019 target would be hit by the end of September. Thus, the frontloading of next year’s bond issuance will only “fill the gap” between now and year-end. As special-purpose bond issuance only accounts for 15% of total funding for local governments’ infrastructure spending, the new measure alone is unlikely to meaningfully accelerate investment growth.3 We have noted in previous reports that in order for local governments to accelerate spending within the current fiscal budget framework, one of three things must occur: more direct funding from the central government, an acceptance by policymakers of more shadow bank lending, or a larger quota for bond issuance. So far we have not seen any of the above-mentioned shifts in policy. Chart 10Local Governments Tightening Belt This Year The only positive sign for local government spending has been a pickup in land sales in Q2, which makes up more than 70% of local government revenues. But, it is far from making up the shortfalls in local governments’ budgets (Chart 10). Local governments are facing considerable fiscal pressure as annual tax revenue growth has fallen to near zero. Critically, the government’s regulatory stance on local government budgets has continued to tighten: Local governments have been ordered by the Ministry of Finance to liquidate state-owned assets to fund their budget deficits this year.4 This austerity measure is also being met with explicit reiteration from the Ministry of Finance on the central government not bailing out local governments, and that local government officials are held responsible for their own borrowing and spending.5 Bottom Line: Optimism surrounding recent Chinese policy announcements is misguided. For now, Chinese policymakers are not upping the pace of stimulus, which underscores the risk to our forecast that growth will soon stabilize. A more meaningful shot of reflation will occur in early 2020 if the economy slows further in Q4, but policymakers will most likely continue their reactive approach rather than proactive. RMB Depreciation: A Plus Or Peril? The RMB’s renewed depreciation since August initially raised fears among global investors that an uncontrolled decline might occur, but these fears have subsided over the past several weeks. Even though the USD-CNY exchange rate has broken the psychological 7 threshold, it is not forming a linear downward trend. Unlike after the August 2015 devaluation, it appears that the PBoC can successfully enact countercyclical measures to guide the RMB’s value higher following each large depreciation (Chart 11). Chart 11PBoC Not Panicking Over RMB Depreciation Fears of uncontrolled capital outflows following the depreciation are also abating. We presented a dashboard for monitoring short-term capital outflows from China in our March 20 Special Report,6 and an update of these indicators suggests that China’s heightened capital controls are holding – i.e., outflows have not escalated as they did in 2015 (Chart 12). Chart 12No Major Capital Outflow Chart 13RMB Depreciation Partially Offsets Tariffs Thus, the conclusion is that Chinese policymakers appear to be in control of the currency. The reduced risk of an uncontrolled decline has allowed policymakers to (passively) provide meaningful stimulus to the domestic economy via depreciation. Indeed, the RMB has not only depreciated against the USD, but also against many Asian currencies including direct trade competitors such as Vietnam and Taiwan (Chart 13). This is helping offset the negative impact of U.S. tariffs on Chinese exporters. But currency devaluation can come with a price tag – in particular for corporations that have borrowed heavily in U.S. dollar-denominated debt. We estimate that $440 billion of U.S. dollar debt will be maturing over the coming two years, for Chinese companies and banks in the aggregate.7 A 12% depreciation in the RMB since April 2018 means that debt servicing costs will be 12% higher for unhedged debtors. This is particularly painful for real estate and financial services companies, two of the largest holders of U.S. dollar-denominated loans, and the weakest sectors in the current economic downturn. Most importantly, while currency devaluation ease the slowdown, it cannot be counted on to stabilize Chinese economic activity on its own. For example, while our earnings recession model suggests that the decline in the RMB since May has reduced the odds of a major decline in economic activity by roughly 20%, the model also shows that such an event is still highly probable (current odds are roughly at 70%). Bottom Line: Barring a successful (even if temporary) trade deal, we expect more weakness in the RMB as a passive source of reflation to aid the economy. But currency devaluation is a double-edged sword, and cannot be counted on to single-handedly stabilize China’s economy if a further slowdown occurs. An Update On Corporate Earnings Against a backdrop of what may turn out to be insufficient policy support, the earnings picture is providing one modest positive for equity investors. While the growth rate in investable earnings per share has slowed significantly over the past year (Chart 14), it has merely fallen to zero and not deeply into negative territory, as what seemingly occurred in 2015-2016. In our view, the risk of a similar collapse in earnings per share (EPS) has been an important factor weighing on Chinese investable equities’ relative performance since June 2018. In reality, a closer examination of MSCI China Index earnings reveals that a huge decline in EPS this year was never really a threat, because the apparent collapse in 2015-2016 did not actually transpire. Changes to the composition in the MSCI China Index that took effect in November 2015 and June 2016 had the effect of depressing index EPS, due to the sizeable inclusion of a set of richly valued stocks. Chart 15 presents BCA’s calculation of “break-adjusted” EPS for Chinese investable stocks, which shows that EPS growth bottomed out at -10% in late-2016, as opposed to the -28% implied by the unadjusted series. Chart 14Investable EPS Has Yet To Contract Meaningfully Chart 15The Potential Downside For Earnings Is Less Than Many Fear Chart 16A Cyclical Recovery In Earnings Has Not Yet Begun The existence of less downside potential for earnings is certainly positive for investable stocks at the margin, but it does not alter the outlook for equity fundamentals over the coming year. We have shown in several previous reports that there is a strong and reliable link between investable EPS growth and China’s coincident economic activity,8 and the continued slowing in the latter does not suggest that a bottom in earnings is imminent. In addition, Chart 16 highlights that while net earnings revisions have recovered from their early-year lows, they remain in negative territory and have stopped rising over the past few weeks. Twelve-month forward EPS momentum, also presented on a break-adjusted basis, is modestly negative, and has recently weakened (panel 2). Bottom Line: The downside risk to earnings for Chinese investable equities is less than many investors fear. But absent stronger credit growth, it remains too early to confidently project a cyclical earnings recovery. Investment Conclusions The historical relationship between credit growth and economic activity suggests that the latter should soon stabilize, which is our base case view for the coming few months. Still, the risk of a further, meaningful deceleration in growth is elevated, given the unprecedented circumstances surrounding the ongoing slowdown. For equity investors, less potential downside risks to earnings than previously feared is a positive at the margin, but the fundamental outlook still hinges on a durable pickup in economic activity. Over a 6-12 month time horizon, this implies that one of two scenarios will unfold: The economy will stabilize in response to the easing that has already occurred (i.e. our base case view). The economy slows further in the near-term, prompting a more significant policy response that leads to an even sharper pickup in activity. Chart 17Investable Stocks: An Overshoot To The Downside? In the first scenario, investable stocks have probably overshot to the downside versus the global benchmark and thus will very likely outperform from current levels. Near-term performance is likely to be flat-to-down, as investors await hard evidence of a sequential improvement in growth (Chart 17). In the second scenario, investable stocks are at potentially acute near-term risk, but will likely eventually outperform global stocks once activity begins to pick up sharply. In this scenario, the outperformance of Chinese equities will commence later, but would likely still occur by the tail end of our cyclical investment horizon (6-12 months). As a final point, we are not ruling out the possibility of a temporary trade deal between the U.S. and China, as both sides have the incentive to avoid a further escalation and are now showing goodwill towards constructive negotiations. This may change our tactical view on Chinese stocks, but our cyclical view remains focused on China’s domestic policy and economic fundamentals. Jing Sima China Strategist JingS@bcaresearch.com Footnotes 1 PBC Official: The RRR Cut Aims at Bolstering Real Economy, September 6, 2019 2 China to accelerate the issuance and use of special local government bonds to catalyze effective investment, China State Council, September 4, 2019 3 Please see Emerging Markets Strategy Special Report, “Chinese Infrastructure Investment: A Ramp-Up Ahead?”, dated August 1, 2019, available at ems.bcaresearch.com 4 China’s Local Governments Sell Assets to Make Up for Revenue Loss, Caixin, September 3, 2019 5 http://www.mof.gov.cn/zhengwuxinxi/caizhengxinwen/201909/t20190906_3382239.htm?mc_cid=eb2b199651&mc_eid=9da16a4859 6 Please see China Investment Strategy Special Report, “Monitoring Chinese Capital Outflows”, dated March 20, 2019, available at cis.bcaresearch.com 7 Please see Emerging Markets Strategy Special Report, “China’s Foreign Debt, And A Secret Weapon”, dated September 12, 2019, available at ems.bcaresearch.com 8 Please see China Investment Strategy Weekly Report, “Threading A Stimulus Needle (Part 2):Will Proactive Fiscal Policy Lose Steam?”, dated July 24, 2019, available at cis.bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations
Highlights Portfolio Strategy Intensifying recession fears, rising risks of ineffectual monetary policy, and escalating trade policy uncertainty that is shattering corporate America’s capex plans, warn that sizable drawdown risks persist in the broad U.S. equity market in the upcoming 3-12 months. The transition from a virtuous to a vicious EPS-to capex cycle, souring global growth, the firming U.S. dollar that is weighing on cyclical/defensive pricing power and exports, and deteriorating relative balance sheet (b/s) and relative operating metrics compel us to put the cyclicals/defensives portfolio bent on downgrade alert. Recent Changes The cyclicals/defensives portfolio bent is now on our downgrade watch list. Table 1 Feature The SPX moved laterally last week, and remains below the critical 50-day moving average. Recession worries intensified on the back of the first sustained 10/2 yield curve slope inversion. Coupled with the trade war re-escalation, they remain the dominant macro themes. Worrisomely, BCA’s Equity Selloff Indicator captures these dynamics and continues to emit a distress signal (Chart 1). Equities have been relatively resilient in the face of these headwinds. Investors are hoping not only for a U.S./China trade deal, but also that the Fed’s cutting cycle will save the day. Chart 1Mind The Gap What caught our attention from all the speeches at the recent Jackson Hole Symposium was RBA Governor Philip Lowe’s speech, especially the section titled “Elevated Expectations That Monetary Policy Can Deliver Economic Prosperity”.1 Lowe highlighted that “When easing monetary policy, all central banks know that part of the transmission mechanism is a depreciation of the exchange rate. But if all central banks ease similarly at around the same time, there is no exchange rate channel: we trade with one another, not with Mars. There are, of course other transmission mechanisms, but once we cancel out the exchange rate channel, the overall effect for any one economy is reduced. If firms don't want to invest because of elevated uncertainty, we can't be confident that changes in monetary conditions will have the normal effect (stress ours).” The perception that the Fed is going to be the savior of the economy is a big risk, and when reality hits that President Trump’s tariffs are a shock to global final demand and presage profit contraction, volatility will skyrocket (please refer to Chart 3 from the August 19 Weekly Report). Importantly, the virtuous capex upcycle that has been in motion since the Trump inauguration when CEOs voted with their feet and started investing, has ground to a halt according to national accounts (Chart 2). U.S. non-residential fixed investment subtracted from GDP growth last quarter, and we doubt the Fed’s fresh interest rate cutting cycle will arrest the fall. Leading indicators of capital outlays point to additional pain in coming quarters (Chart 2). As a reminder, generationally low interest rates and a real fed funds rate near zero hardly restrict expansion plans. Chart 2Free Falling The shift from a virtuous to a vicious capex cycle is a theme that will start gaining traction as the year draws to a close. While pundits are dismissing the recent steep fall in capex as a one off, our indicators suggest otherwise. The middle panel of Chart 3 clearly depicts this emerging dynamic. Profit growth peaked in 2018 on the back of the massive fiscal easing package and capex is following suit, albeit with a slight lag. There are high odds that a looming profit contraction will further shatter frail animal spirits, sabotage the capex upcycle and tilt into a down cycle. Tack on the ongoing trade uncertainty, and CEOs are certain to, at least, postpone deploying longer-term oriented capital. Worryingly, this transition from a virtuous to a vicious capex cycle is not limited to a few cyclical sectors as we would have expected on the back of the re-escalating Sino-American trade tussle. In fact, basic resources’ and non-capital goods producers’ capital outlays are decelerating, warning that corporate America is in the early stages of retrenchment (bottom panel, Chart 3). Chart 3EPS-To-Capex Down Cycle Chart 4Capex… Charts 4, 5 & 6 break down sectorial capex growth using financial statement reported data from Refinitiv. Seven out of eleven sectors are steeply decelerating from near 20%/annum growth to half that; given that these sectors comprise more than 72% of the total capex pie, they will continue to weigh on overall stock market reported investment. Chart 5…Per… Chart 6…Sector Similarly, the news on the cyclicals versus defensives capex profile is grim. Trade uncertainty and the global growth soft patch has dealt a blow to deep cyclical expansion plans and leading indicators signal that the cyclicals/defensives capex will flirt with the contraction zone in the coming quarters (Chart 7). In sum, intensifying recession fears, rising risks of ineffectual monetary policy, and escalating trade policy uncertainty that is shattering corporate America’s capex plans, warn that sizable drawdown risks persist in the broad U.S. equity market in the upcoming 3-12 months. As a reminder, this is U.S. Equity Strategy’s view, which contrasts BCA’s sanguine equity market house view. Chart 7Relative Capex Blues This week we update our cyclicals versus defensives bias (we are currently neutral) and are compelled to put this portfolio bent on our downgrade watch list. Put The Cyclical/Defensive Tilt On Downgrade Alert Roughly two years ago, when nobody was talking about the brewing capex upcycle, we penned a report titled “Underappreciated Capex” and posited that: “It would be unprecedented if the current business cycle ended without a visible capex upcycle. Since the 1980s recession, all four recessions were preceded by stock market reported capex soaring to roughly a 20% annual growth rate. At the current juncture, capex is merely on the cusp of entering expansion territory and, if history at least rhymes, a significant capex upcycle is looming.” Fast forward to today and as historical empirical evidence had suggested, capex growth peaked near the 20%/annum mark (Chart 3 above). If our assessment is accurate that capex has now likely hit a wall and the virtuous EPS-to-capex cycle reverses to a vicious down cycle as EPS are now contracting, then deep cyclical high-operating leverage sectors are in for a rough ride. This will especially be true if the global recession warnings also morph into an actual recession on the back of the re-escalating Sino-American trade war. More specifically, our capex indicators are firing warning shots. Capex intentions according to a plethora of regional Fed surveys are sinking steadily, which bodes ill for cyclicals versus defensives (Chart 8). One key driver of the capex cycle is China and the emerging markets (EM). News on both fronts is grim. Our real-time indicator that gauges China’s reflation efforts (monetary and fiscal) turning into actual economic activity is Chinese excavator sales that remain in the doldrums (top panel, Chart 9). Chart 8Drop In Capex Will Weigh On Relative Profits Chart 9Elusive Global Growth Granted, global growth remains elusive as we highlighted last week and while softening Chinese economic activity is weighing on global growth, European and Japanese GDP growth is also decelerating with a number of economies already in the contraction zone (bottom panel, Chart 9). Melting global bond yields reflect these growth fears and warn that the relative share price ratio has more downside (middle panel, Chart 9). Export growth is an important indicator that closely tracks the ebbs and flows of global trade. When the trade-weighted U.S. dollar appreciates it dampens trade, the opposite is also true. Currently the Fed’s trade-weighted greenback based on goods has vaulted to cyclical highs, warning that the path of least resistance is lower for trade, thus a net negative for relative export and profit prospects (Chart 10). Similarly, EM capital outflows exacerbate the ongoing global growth blues and put additional strain on EM economies as depreciating currencies sap consumer purchasing power (top panel, Chart 10). The implication is that EM final demand is in retreat. The rising U.S. dollar not only deals a blow to basic resource exports via making them less competitive and leading to market share losses, but it also undermines cyclical sectors' pricing power. The top panel of Chart 11 shows that deflating commodity prices are exerting downward pull on relative share prices. The ISM manufacturing survey’s prices paid subcomponent corroborates this deflationary backdrop. Keep in mind that operating leverage cuts both ways, and now that the pendulum is swinging the opposite way revenue contraction in these high fixed costs industries will fall straight off the bottom line (Chart 11). Chart 10Rising Dollar Dollar Dampens Trade And… Chart 11…Saps Pricing Power Our macro-based cyclicals/defensives EPS growth models do an excellent job in capturing all these moving parts and signal that defensives have the upper hand in the coming quarters (bottom panel, Chart 8). Turning to operating metrics, the inventory buildup in the past few quarters coupled with a softness in overall business sales underscore that relative share prices will continue to trend lower (top panel, Chart 12). On the balance sheet front, relative net debt-to-EBITDA has troughed and widening junk spreads and the inverted yield curve warn that a further relative b/s degrading looms (second & third panels, Chart 12). If our thesis pans out in the coming months, then cash flow growth will come under pressure as the vicious capex cycle flexes its muscles foreshadowing a rise in bankruptcy filings. Already, the news on the profit margin front is disconcerting. Historically, the ISM manufacturing index and relative operating profit margins have been joined at the hip and the recent flirting of the former with the boom/bust line points toward an ominous relative margin squeeze (bottom panel, Chart 12). Chart 12Poor Financial & Operating Backdrop… Chart 13…But Excellent Valuations And Technicals Finally, soft versus hard data surprise oscillations have an excellent track record in forecasting relative share price movements. The current message is to expect additional weakness in relative share prices (second panel, Chart 13). While most of the indicators we track signal that the time is ripe to downgrade this portfolio bent to an underweight stance, bombed out relative valuations, and oversold technicals keep us at bay, at least for the time being (third & bottom panels, Chart 13). However, we are compelled to put the cyclicals/defensives ratio on downgrade alert to reflect the transition from a virtuous to a vicious EPS-to-capex cycle, souring global growth, the firming U.S. dollar that is weighing on cyclical/defensive pricing power and exports, and deteriorating b/s and operating metrics. The way we will execute this downgrade will be via a downgrade of the S&P tech sector (for additional details on the S&P tech sector's downgrade mechanics please refer to last Friday’s U.S. Equity Strategy Insight Report). Bottom Line: Stay on the sidelines in the S&P cyclicals/S&P defensives ratio, but put it on downgrade alert. Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com Footnotes 1 https://www.rba.gov.au/speeches/2019/sp-gov-2019-08-25.html Current Recommendations Current Trades Size And Style Views Stay neutral cyclicals over defensives (downgrade alert) Favor value over growth Favor large over small caps