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This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.
China‘s Rebound Bodes Well
Momentum Strategies Report
Clif Droke Market Analysis
July 16: In the past, significant rallies in China’s market have led bull-market rallies in the U.S. market by anywhere from several weeks to several months. Rarely does an upside move in the Shanghai Composite of more than 10% fail to signal higher prices ahead for the U.S. major averages from an intermediate-term (3-6 month) perspective…
By the same token, China’s equity market normally falls into the hands of the bears several months before the bears take over Wall Street. The point to remember is that China typically exerts a leadership position over the U.S. stock market due to its outsize role in the global economy. Accordingly, it’s no exaggeration to say, “What’s good for China is good for the world economy.”
It’s not just China’s rebounding equity market that’s sending a positive message for the U.S., but also several key commodities which are heavily utilized by China’s industry. Foremost among these is copper, the price of which serves as a barometer of the global economy’s health. “Dr. Copper” has been undergoing an impressive resurgence this year—in part because of tight supplies—but also because of increased industrial demand (not to mention anticipated future use). An upward-trending copper price can therefore be considered a harbinger of strength for America’s economy.
—Clif Droke
All Aboard Equities
UBS House View
UBS Global Wealth Management
July 16: To earn positive real returns over the long term, there is no alternative to owning equities. The Federal Reserve has been more explicit than ever before about its commitment to support the economy through the crisis and its ability to live with rising asset prices. Using market-based forward rates, markets, encouraged by the Fed, don’t expect higher rates for years to come.
For investors, this creates at least two problems. First, portfolio income is getting harder to find almost every day. Second, cash and high-grade bonds are expected to deliver negative real returns for the foreseeable future.
Given the dire outlook for returns in cash and bonds, for investors with a long-term focus, our core recommendation is to take steps to filter out the short-term noise and start getting invested in stocks for the long term. Despite the rally, based on equity risk premiums, global stocks are still cheap relative to bonds, trading in the 10th percentile of relative valuation since 1997. Historical experience suggests that excess liquidity provision will support further expansion in equity multiples.
—Mark Haefele
Behind the Rise in Retail Sales
Macro Note
Avalon Advisors
July 16: Being able to reconcile the labor market collapse with the seeming V-shaped recovery in retail sales seems impossible.
In actuality, it isn’t all that difficult. The level of transfer payments for unemployment insurance is extreme. The $1,277.9 is in billions on an annual rate basis like GDP, and therefore it is a bit distorted. But it gets the point across—the level of income replacement has been extreme. The deficit is 14% of GDP. In other words, unemployment insurance has offset the decline in incomes that would have normally been associated with this level of shock to the economy.
With 20% of the labor force claiming unemployment benefits, it is still not all that surprising that retail sales bounced back. The question is whether or not this can continue. And that is difficult to answer. Employment will need to pickup substantially to offset the loss of the elevated transfer payments. The July data will be telling, but the August data will be the answer as the elevated payments begin to run out.
—Samuel Rines
Too-Popular Tech Stocks
Insights
Causeway Capital Management
July 14: Many active investors justify the valuations of technology giants by using huge revenue trajectories over decade-plus timelines and focusing on the cost and competitive benefits of achieving dominant scale. This low interest-rate environment further helps them defend premium valuations. Your investment philosophy will dictate your comfort with that approach. Philosophical differences aside, I believe investors in those companies fail to recognize that the widespread popularity of these stocks may undermine the long-term success of the investments. Most alpha (return above a benchmark) from information technology stocks comes from multiple rerating. An already well-liked stock has little room for an upward rerating, but plenty of downside risk if the company disappoints. Widely favored stocks carry with them substantial misexecution risk that investors often overlook.
—Brian Cho
Follow Buffett’s Lead in Energy
Focus Energy
NDR Ned Davis Research
July 13: Recently
Berkshire Hathaway
(ticker: BRK.A) announced the acquisition of
Dominion Energy’s
(D) midstream natural-gas assets. The deal nets [Berkshire CEO] Warren Buffett close to 8,000 miles of natural-gas transmission pipelines and 900 billion cubic feet of natural-gas storage capacity. Upon closing, Berkshire will own 18% of the nation’s interstate natural-gas pipelines. Energy investors should take note.
Energy is now the highest-yielding sector in the market. The coronavirus has widened the yield spread between energy and all other major sectors. (Energy now yields 220 basis points more than the second-highest-yielding sector, utilities.)
Why has this happened? Our hypothesis is that investors now view energy as the “shortest duration” sector within the market. In other words, energy assets are expected to deliver a large proportion of their total cash flows in the near term. This makes sense. Existential risks are rising. Peak demand, political risks, and poor management have called into question the terminal value of traditional energy assets. In response, investors have shortened their acceptable payback period and want dividends rather than growth capex and promises from management.
Facing this reality, how should investors respond? Investors should look for energy assets where the cash-flow runway is longer than being priced for, plus [there is] the stability to survive the coronavirus. Well-established natural-gas transmission pipelines fit this description.
—Warren Pies
Buy Staples, Sell the S&P 500
Systems & Forecasts
Signalert Asset Management
July 13: One of my long-term favorite sectors, the defensive consumer-staples sector, held up well today, losing only 0.2%. In relative strength, the
Consumer Staples Select Sector SPDR
(XLP), is lagging the
SPDR S&P 500 Trust
(SPY) year-to-date and the relative strength XLP/SPY is near its low for the year. In fact, XLP/SPY is at a 21-month low. Since 2000, relative-strength lows in the XLP have been a good time to take profits in the S&P 500 or become more defensive generally. Consumer staples appears to be an attractive area to hold as part of your equity exposure.
—Marvin Appel
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