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Editor's Note: Hamish Risk | October 13, 2020
The extent of the equity rally from the March lows has caused many to question current valuations and ask whether they are sustainable given the myriad of headwinds facing the global economy. In today’s Macro Briefing, however, View from the Peak challenges the conventional wisdom, arguing that there is currently a huge undervaluation factored into stock markets thanks to a stubborn refusal by investors to rethink the use of discount rate norms. There is more positive news for equity investors as Forest for the Trees explains why they are poised to benefit as the US authorities embark on an inevitable series of stimulus packages to fend off bankruptcy, while Blonde Money sets out why fears of a delayed result in the US election are overblown. Elsewhere, sterling is in the spotlight, with HSBC and ECR Research warning the pound is set to come under pressure – Brexit deal or no deal.
discount rates fundamental equity analysis View From The Peak
1. Introducing 2PP – the stuff that mattersThere is a compelling reason, anchored in the misuse of discount rates, for believing the stock market is considerably undervalued to the tune of between $4.5trillion to $5.6 trillion, says Paul Krake from View from the Peak. He has teamed up with Paul Jeffrey of Skiff Capital Advisors to launch 2PP, an experiment designed to consider the factors that will unlock value for investors over the next five to ten years. At the heart of the experiment, says Krake, is a five to ten-year investment horizon for twenty of the world’s most economically substantial, commercially innovative, and societally transformative companies. With this long-term perspective, he says 2PP will look at business developments within those organisations that are not regularly discussed, analysed or quantified, but should be. Krake has kicked off a series of reports on the experiment with a note on flawed discount rates – an issue that he says affects all stocks. As he explains, the 2PP view refutes the generic idea that the current market is over-valued and instead states a countervailing view that the market is actually considerably undervalued due to a general miss use of applied discount rates by not only stock analysts but many in the wider community of investment professionals. Simply put, says Krake, the discount rates commonly being applied on many large-cap US stocks, but mega- and large-cap tech stocks in particular, are far too high.
bitcoin gold US fiscal deficit volatility Forest for the Trees
2. US fiscal position is irrecoverableThe third-quarter US Treasury Borrowing Advisory Committee (TBAC) report is likely to have made the US fiscal position irrecoverable without serial stimulus packages says Luke Gromen at Forest for the Trees. He notes the TBAC data showed US “Big 3” Federal expenditures – entitlements, defence, and interest expense – hit 142% of tax receipts. With tax hikes and spending cuts off the table for fear of sending the economy further into recession, investors should expect further stimulus packages – unless they believe the US will be the first state in history to go bankrupt for lack of printed money, says Gromen. Markets are, he says, therefore in the hands of Washington politicians getting stimulus done in time, each time the prior stimulus runs out. As more investors understand this, it speaks to a strategy of owning gold, owning stocks, and owning volatility, either minimally-levered or unlevered, says Gromen.
US presidential elections Blonde Money
3. US Presidential election – delayed result unlikelyWith rapidly changing electoral procedures, high expected turnout, and President Trump’s public promises to challenge the eventual result, predictions of election night chaos have been ubiquitous, says Helen Thomas at Blonde Money. She says many believe that the announcement of a winner could take weeks, arguing that mail-in ballots and recount requests could delay what is usually a relatively swift process. However, in the states that really matter, the factors required for such a scenario are simply not present, according to Thomas. She says despite the conventional wisdom, mail-in voting is more likely to expedite than delay results, especially given the current polling averages, and while some have spoken of the possibility of a flood of late ballots, the familiar nature of the candidates and the electoral law of some states make this unlikely. Even if polling were to tighten in the coming weeks, it would have to be a wafer-thin race for any of these factors to have a significant delaying effect, argues Thomas.
Brexit European Union Trade ECR Research
4. Deal or no deal, Britain will end up an outsiderAndy Langenkamp at ECR Research says a blundering UK and a frustrated Europe could unintentionally stumble toward the worst possible outcome of a no-deal Brexit, but his preferred scenario remains that of a hard Brexit with an agreement on a number of key issues, while other stumbling blocks are pushed into the long grass. He says, however, it is inevitable that the UK is unlikely to benefit from a Brexit deal, whichever way it turns out and there are already many signs that the UK, which is inextricably linked with Europe, will have to make sacrifices. In view of the UK’s bleak prospects, it is therefore not surprising that the number of short positions on the pound has increased considerably says Langenkamp. However, he notes the extent of the short positioning on sterling cannot be compared to previous periods during which Brexit triggered high tensions, which is why he believes the pound still has some more downside potential if tensions over the negotiations increase further.
Brexit Sterling HSBC
5. Friction burns sterlingDominic Bunning at HSBC has issued a note maintaining his counter-consensus view on sterling, which he expects to weaken materially from current levels, with GBPUSD falling to $1.20 and EURGBP rising to £0.96 by the end of 2020 before a modest reversal in 2021. He notes the pound has been buoyed by a broader increase in risk appetite in recent months, but questions whether this can last in the face of two deteriorating dynamics. First he says, structural trade frictions will rise as the UK finalises Brexit, and the currency is the most likely channel through which a short-term adjustment could be delivered to offset the impact of the greater costs. Second, says Bunning, the cyclical rebound is faltering, and with the UK seeing the largest negative growth shock in Q2 amongst G10 economies, it now faces a slower pace of recovery. Recent upside economic surprises already look unsustainable as greater restrictions are imposed on activity, he adds, while a lack of policy flexibility suggests diminishing government support compared to Q2 and Q3. These two channels both suggest a larger discount to long-term fair value for sterling is necessary, says Bunning, and a 10% does not seem extreme, in his view. He adds an even bigger discount of 20-25% is likely if the UK ends up trading on WTO terms with the EU, pulling GBPUSD down to $1.10 and EURGBP around parity in a no deal scenario. In other words, says Bunning, sterling is set to feel the burn, deal or no deal.