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Editor's Note: Hamish Risk | August 13, 2020
If we had a dollar for every research report we’ve read that tried to make sense of the ever-widening gap between the real economy, and the inexorable rise of the mega-cap tech stocks, we could probably buy 1 facebook share. At this rate, based on a wild assumption that the trend continued well into the future, affording an Amazon share might be achieved sometime in 2150, perhaps never. Vincent Deluard of StoneX has dubbed this the cult of the bull market. ”Locked in their homes, torn apart by politics, and surrounded by economic devastation, investors have erected the FAANMG-driven bull market as their new idol.” However, disturbingly the stock market has become the antithesis of the what’s good for the economy. This bull market, says Deluard, requires financial repression, depression-level yields, ever-greater liquidity injections, and the continued domination of a handful of overvalued tech megacaps. In essence, it’s morphed into a policy target, which Deluard says will ultimately lead to a death loop for pension funds and defined benefit investors. Any other options? We also highlight research looking at the value in emerging market equities and why Japan looks like an attractive option. We also follow up on yesterday’s note on the UK economy, where we commented that the UK government continued to bumble the management of its Covid response, with the Macro Strategy Partnership bemoaning the UK government’s mishandling of the coronavirus pandemic and which explains why the British economy remains enslaved to “specious” science. In our regular ESG segment HSBC explains how forensic accounting techniques can be used to identify often overlooked items of interest and value, amid the continued weaknesses in audit procedures of accounting firms.
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1. The bull market cult is killing the economyLocked in their homes, torn apart by politics, and surrounded by economic devastation, investors have erected the FAANMG-driven bull market as their new idol, says Vincent Deluard of INTL FC Stone. Stocks’ relentless rise since the March low has brought relief and distraction from the economic and political chaos, but the S&P 500 index no longer represents the economy. The FAANMG stocks, whose capitalisation exceeds that of the financial, energy, industrial, and materials sectors combined, account for 5% of the index’ employees and 3% of total debt, notes Deluard. In addition, he argues, the stock market no longer leads the economy: prices and multiples have rebounded much faster than after any prior market bottoms but many economic indicators have failed to confirm stocks’ positive message. Five months after a stock market bottom, Deluard points out, yields usually rise, curves steepen, gold prices drop, and consumer confidence rebounds – the opposite of what is happening today. In fact, he says what is good for the stock markets’ interest has actually become bad for the economy, and vice versa: the bull market requires financial repression, depression-level yields, ever-greater liquidity injections, and the continued domination of a handful of overvalued tech megacaps. On the other hand, says Deluard, a sustainable recovery would require higher yields, lower asset prices, rapid household formation, greater competition, some inflation, gales of creative destructive destruction, and the normalization of monetary policy – which would destroy a stock market captured by long-duration tech monopolies. The stock market, says Deluard, used to be a measure of the economy, but has now become a policy target. This situation – which he dubs the stock market cult – is simply unsustainable and will ultimately lead to a death loop for pension funds and defined benefit investors.
Emerging markets Equities Top Down Charts
2. The bull case for EM equitiesWhile there are some short-term risks for EM equities, the medium-term bullish case remains sound, says Callum Thomas at Topdown Charts. He notes the relatively poor performance of EMFX and the fact that the EM blended PE ratio has crept up towards decade-highs as potential warning signs for investors. However, Thomas points out the PE10 is still showing up cheap for EM, while also supporting the medium-term case is the substantial easing of EM monetary conditions, and still quite muted sentiment, which should all serve as a powerful tailwind for EM equities. On a relative basis, at a high level EM is still struggling to shake off the 10-year relative bear market versus DM, he adds. Breaking it down, Thomas notes EM has actually been gaining ground versus DM ex-US and looks close to breaking out on a relative basis, while versus the US, the downtrend remains fairly clearly intact. However, he says that EM is positioned to perform well and offer superior value to DM over the medium-longer term – particularly should dollar weakness see follow-through into a multi-year bear market – given some of the longer term trends, positioning and valuations. Finally, Thomas also looks at the relative performance of EM ex-Asia, which has been in a 10-year relative bear market versus EM Asia. EM ex-Asia, he says, has been left behind by EM Asia, and based on historical patterns, relative value, and positioning, has good catch-up prospects over the next year.
Asia equities Asia tech Quant Insight
3. TOPIX and Asia BIG TechQuant Insight’s framework looks to understand asset price movements and valuations by distilling signals from its quant models that cover thousands of securities in real time. Their secret sauce is that they use algorithms to untangle and isolate which macro variables (typically correlated) are driving asset prices. Furthermore, their models can identify which assets will be most sensitive to changes in particular macro factors. Their latest report focuses on Asian equities, which show strong correlation to macro factors according to QI. Currently, the vast majority show valuations in line with the firm’s macro-warranted model value, but the TOPIX is the outlier, standing cheap to the model. Credit spreads and measures of risk aversion like the VIX between them explain half of model explanatory power, says QI, suggesting the TOPIX is an attractive vehicle for those who want a “risk on” bet in Asian equities. Meanwhile, at the single stock level, Asia is experiencing its own big tech rally, according to the firm, which notes Tencent and Alibaba have both hit record highs; while Samsung Electronics and Taiwan Semiconductor Manufacturing have been instrumental in pushing the KOSPI and Taiex higher. Versus their macro regimes, QI says Taiwan Semiconductor looks rich already, however, the other three are all close to model fair value suggesting, from a macro perspective, Asian tech bulls face less in the way of any potential headwinds.
COVID-19 testing UK Macro Strategy Partnership
4. UK suffers worst loss of GDP and freedomJames Ferguson at Macro Strategy Partnership says the people of the UK are slaves to an increasingly specious science, with the fact the country’s economy suffered the worst loss of GDP in the first half of the year among its developed-world peers – and that its prospects are the grimmest – down to the fact that the relaxation of lockdown restrictions in Britain has been the most pedestrian seen anywhere. In a forensic analysis of the debacle that appears to have constituted the UK government’s so-called “follow the science” strategy to contain Covid-19, he explains how scientists started criticising the fact that it had given disproportionate weight to a small cadre of modellers with a poor track record as early as April. According to Ferguson, the numbers suggest the UK government knows that its testing strategy remains deficient, but has done nothing to change it, and is now stuck with PCR swab tests that have far poorer reliability than ever imagined. The so-called science is increasingly looking like a complete mess, he says, yet its justification for economic hardship goes on. British citizens, according to Ferguson, deserve better.
corporate governance ESG HSBC
5. ESG: Audits analysedWe have previously flagged up problems faced by investors who are reliant on an auditing profession whose reputation appears to be in tatters to make their allocation decisions. A string of high profile calamities, such as the failure of ESG ratings/data providers to flag up the corporate governance problems at Wirecard, has led for calls for reform in the auditing profession. It is timely, therefore, that Dylan Whitfield, HSBC’s head of forensic accounting, has put out a report as the UK’s Financial Reporting Council (FRC) annual inspection finds that lessons have still not been learned, or where they have improvements are not being made sufficiently quickly. He says the FRC found that an “unacceptable” 33% of audits required more than limited improvements, with the body particularly frustrated that auditors continue to provide insufficient challenge to management and the key reporting and accounting judgements that they make. According to Whitfield, auditors are still struggling with assumptions and forecasting in relation to impairment reviews, revenue recognition, long-term contracts, asset valuation and provisioning. Despite the shortcomings he thinks ignoring audit reports is a lost opportunity, however. Indeed, Whitfield explains how investors can use a forensic approach to identify items of interest and value – that are often not obvious – based upon the “unusual items”, the risks identified by the auditor, material areas of accounting subjectivity, and auditor independence and appointment.