A number of interesting big picture thoughts, all linked by the idea that overpriced US Tech stocks might start to face some competition from cheaper alternatives.
We start with the macro driver which could be a weakening US dollar. Now, this has been a recurring suggestion for a number of years. Everyone and their aunt seem to have predicted a weaker dollar and it hasn’t happened – yet. That doesn’t mean it won’t or can’t happen and Cross Border Capital (who’ve also been predicting a weaker dollar for some considerable time) reckon they’ve spotted the first signs that footloose global capital might be slowly turning bearish on the greenback.
“ The prospective deterioration in US fiscal arithmetic, the speed, and size of the US Fed’s monetary response to the COVID crisis and their willingness to take on serious inflation risks, suggests that a major inflexion in the US dollar may be underway? If this turns out to be a normal cycle, then investors should expect a 25% drop in the DXY effective dollar index over the next 2-3 years. In the early stages, at least, this would underpin a sizeable rally in global risk assets, boost commodity prices and Emerging Markets and bolster gold and crypto-currencies. Eurozone and the Euro could be key winners.”
Cross Border seems to have based their call on in house trading indicators – these include upcoming US forex risk which has decisively rolled over and the capital-flow sensitive Swiss Franc/ US dollar cross rate itself which “ also appears to be changing direction. This background does not point to a collapse in the US unit, but downward pressures are plainly building.”
The chart below is I think an excellent overview of the long-term strength of the US dollar – and a hint of why it might have reached peak levels in the last few weeks.
Will Value’s time ever come?
My colleague Scott Longley on ETF Stream has a great round-up of reports which all paint a dismal picture for value investing. Again, one read this through the prism of dollar dominance. Most owners of capital seem to want safe-haven US fixed income assets and/or ‘defensive’ (!?) US Tech growth assets. That’s left pretty much the rest of the world as a value stock as well as a large chunk of the US equity market.
A few weeks ago it looked like the worm was finally turning and that value would have its day. But that rally looks like its run out of steam. According to ETF Stream – the article is HERE – a recent analysis from financial intelligence firm Qontigo confirms that both value and earnings yield strategies “have both underperformed since the start of the crisis, aside from a few days in May, where value in the US made a strong comeback. This in itself, Qontigo suggested, was not a full rebound and was confined to the US with other regions failing to follow suit. Indeed, for May as a whole, the only region where value managed a positive performance was the UK, and that by a hair’s breadth.” The table below contains the full grisly details of value’s under performance in 2020.
But not everyone has given up on value as such. Last week analysts from Morningstar spun through their core investment ideas and alighted on cheaper, value-driven stocks as one source of potential alpha. They remind us that “Value investing shouldn’t be confused with conservative investing. The aim is not to be conservative investors who are always going to hold lots of cash. When things look expensive, like they have for the past few years, we’ll hold lots of cash to buffer the portfolios during volatile times. But the further markets fall, the more likely we should be to invest that cash into new opportunities. Should markets fall further, we can take advantage of the opportunities that arise.”.
The big table below summarises most of Morningstar’s conviction ideas.
Highlight of Our Convictions:
Source: Morningstar Investment Management, conviction levels confirmed at 15 May 2020. *Overall conviction is a long-term judgement built on a five-point scale from “Low” to “High”. Typically judged on a 10-year horizon, a “Low” means that reward-for-risk is likely to be subdued, whereas a “High” means reward-for-risk is appealing. This incorporates our four pillars of conviction including 1) absolute valuations, 2) relative valuations, 3) fundamental risk and 4) a contrarian scorecard.
Which leads us back to the thorny topic of European stocks. These have had a decent run so far in the late May rebound but may have further to go, even though the region contains an abundance of value stocks.
MSCI European equity analysts reckon that the key driver isn’t necessarily earnings rebounds. If anything they sound deeply negative – their top-down EPS estimates are a 45% drop this year followed by +45% in 2021 and +25% in 2022. Instead, they reckon that the EU Recovery fund is a key tailwind – “ the proposed EU Recovery Fund provides a more positive narrative for Europe and should mark an important inflection point for markets, given low investor positioning/sentiment. Lower risk premia across the region should justify equity valuations that are at or above the top of the 10Y range”.
On this basis, they argue that there could still be 8% upside to their 12M index target.
“From an index-weighted perspective, our analysts’ bottom-up EPS forecasts are consistent with MSCI Europe EPS declining 32% this year (consensus is -28%), while their 2022estimates are 10% below consensus. Based on our analysts ‘2Y forward EPS forecasts, Food Retail, Insurance, Telecoms and Real Estate look cheapest versus history in both absolute and relative terms. In contrast, Energy, Retailing and Diversified Financials look most expensive.” Crucially apart from the insurance sector most of this upside potential is likely to be found at the stock rather than sector level. They highlight Capgemini, Daimler, Elis, Hays, Johnson Matthey, M&S, Meggitt, Sandvik, Sodexo and Veolia as pricing in the least EPS optimism. Their analysts also highlight BP, Carnival, Deusche Lufthansa, Norsk Hydro and Volkswagen as “pricing in the most optimism on EPS”.