And what a Dark Quarter that was!

Subsequent to the last financial disaster, Nassim Taleb wrote about a foreseeable ailing set of interwoven financial structures and called it the “Black Swan”. Much like the making of a previous disaster and LTCM and the abrupt “Failure of the Genius”. Walking through the corridors of a large Swiss institution, back in 2008, I heard someone saying “how could anyone in their right mind think of such shabby debts structures as their asset”.

To a Wall Street insider, the failure of such concocted financial instruments, by a bunch of crooked financiers, was not a surprise. On the other hand, “Covid-19” was brewing silently in the south eastern part of our hemisphere and succeeded to take down the economy and the financial markets in the entire world. Perhaps it is time for Nassim to write about this exogenous public health problem, sending shock waves into the economy and call it the “Real Black Swan” or “the Black Crown” …

This time around no one is worried about the collapse of the financial systems, like they did last time. Well not yet. This is the result of an exogenous phenomenon, leading to the collapse of the credit markets.

The Disconnect in the Markets

Market corrections are normal and healthy until you are in one yourself. And by definition what actually makes people sell, to the degree they did, was that there was too much enthusiasm going into the peak, during the early part of this year. The way certain stocks, i.e., likes of Tesla and Apple were rallying was totally disconnected from the rest of the word. When Apple jumped to all-time highs, earlier on this year, the average stock on S&P 500 was actually down.

The way the stock market was acting at the back of a few Mega Caps Stocks was kind of Bunkers (which is a technical term :-), commented by Tony Dwyer (Chief market strategist at Canaccord) on CNBC. So on January 20^th we thought there was going to be a mere 5 – 10% correction concentrated on the biggest names. And then of course the Coronavirus hit that next week. Which brought in play a fundamental Dynamic that can weaken the entire global economy in 2020.

The cause of the action, this time, is not economic but health related and economically the banks are very strong. Though we are too far from a cure or the vaccine, there are a few Biotech companies, like Gilead Sciences, which is now opening up two one thousand patient trials. The initial stock piling orders are to prepare the clinical supplies. The other aspects are the preparation for broader use of the therapeutics. Although they don’t cure the disease, they are to treat more severe patients with coronavirus.

At Swiss Wealth Solutions we are not virologists, and hence unable to throw more colour onto this. Suffice to say, that certain company valuations were stretched coming into this and hence the severe pull back. Therefore, if it wasn’t Corona, it would’ve been something else. The rate of decline, however, is far sever than it was even with the 2008 financial crisis. Some of which can be contributed to the sharp decline in travel and leisure activities and hence overall consumption.

Having said that, we do realise the pain caused by this virus and our heart goes out to all who have and are suffering from this outbreak.

The Real Economy

We are already in a technical depression!

We had observed weakening consumer confidence since the second half of 2019. Coupled with the pandemic virus situation we expect a weaker global growth and profits and that at least for the first two quarters of 2020.

We are in unprecedented bad times. Worsening credit cycles will affect the banks, by becoming a collateral damage. And if economic shutdown jeopardises a lot of the outstanding corporate and consumer credit, the banks will be going down, even though this time they are not the epicentre of this whole thing!

Although, both FED and the congress are poised to stop the economy from a calamity but if we are all staying at home, it is going to be a big problem. There are however, limits as to what FEDs monitory policy and the announcement of an unlimited QE on its own can achieve. The FED is trying everything it can to stop this down turn and on the global growth. Despite all theses, the earnings estimates, are yet another unknown and hence work in progress.

The Supply Side – Despite FED’s cuts, we’ve seen some pervasive selling now that the story has been understood i.e., no matter how much liquidity gets pumped in the system, which according to some is already too much, it can neither spur the auto manufacturing and nor the production of the iPhones. Workers need to return to the shop-floor before anything can be produced.

The Demand Side – on the other side of the supply is the demand risk. Again here, although China does represent a big portion of the global demand, it is and growing to be a major part of it. And when the consequences of this outbreak hit the demand side and that specifically in Europe and the US, we will then see the dark side of the Swan.

S&P 500 Valuations

We have now gone from almost the highest valuations for the past 10 years, i.e., 18 x forward earnings, the P/E ratio to almost the neutral levels, that is around 15 x the earnings. Since 2014 we have been elevated into this higher zone of valuations, between 14 to 18 times the earnings. Within the past 5 years, due to easy monitory and recent fiscal conditions, we haven’t spent a lot of time below 14 x the forward earnings, except in December 2018, when we did dip below 15x the earnings. This however is on the slide now. The huge caveat today, is the fact that we don’t know the faith of the forward earnings forecast. The numbers haven’t come down that much on an aggregate basis since the end of January. With the sudden slowdown of demand on the markets. And the second wrinkle is how you equate the forward earnings of the equities, where they are now and where the bond yields are.

We hadn’t reached the valuation tipping point till Feb 21^st. and for the Coronavirus, the US was the safe haven. Overall, companies tend to metabolise a shock and then recover. Hence the question, will it be a U or a V shaped recovery. The lost revenues, in certain segments of the industry, like travel and entertainment, cannot be recovered. I won’t be travelling to Spain twice this year, just because I missed on my spring vacations. And neither will I be drinking twice as much Starbucks latte, just because I didn’t consume so much in the earlier part of this year.

And hence the downturn in the discretionary spending is given. Some argue that we are already in technical recession, with almost 90% of the industry in lockdown. Although, within certain segments like Finance and IT remote working does function, in the manufacturing industry this is not the fact.

Therefore, if this continues for a long time both the US and the European governments will have to come to the rescue of the Airlines and small businesses that have fallen victim to an exogenous event, through no fault of their own.

Cyclicals vs. the Defensives

We are not oblivious about market conditions and do realise the effects of the global slowdown, however, when you look at certain industrials, likes of Deere for example, and look into their valuations, on a relative multiples, they are trading down at around the financial crisis. Therefore, we do think that a lot of the bad stuff is already backed in with such sentiments. And this sector never really recovered from the trade wars with China. And therefore we think that this sector has really been de-risked to an extent. And that specifically after last Monday’s (March 9^th) total capitulation.

And then we have the ultra-defensives, i.e., the Utilities, which give you some of the best yields and there are not a lot of political or China risk within this sector. Effects of virus however, are yet to be observed and they are not overvalued. Now, if the interest rates rise, this sector can be vulnerable. But hey, if things muddle along as they do, a rate hike is by no means on the horizon. Quite the contrary, in fact the US market is not expecting a rise this or even the early parts of the next year.

Big Tech

The big tech. were clearly in the lead in taking us to the new elevated highs, before the virus raised its head. It was also part of the complacency. These were the easy names and whoever went in at levels above $300 for AAPL and such, is now feeling the pain. We took some of our chips off the table when AAPL reached $304 and that across all big tech. and some amongst us where complaining that we had gone out too early, when it was trading above $320. However, we were all very content now that we could buy it back around $270.

Having said that, it is always easier for the retail investor to come in when everything is going higher and everybody was piling in. Only to realise that the professionals are pulling out gently and when the ETFs get to the market, that’s when all lights tend to get red in Wall Street. What do they say? “The highest fall the fastest” and now we have it. There were no rhyme nor reason for the group to be so elevated, when at the same time other stocks were tanking within S&P 500. Except for the fact that the mass were rushing in, in order not to miss on the action and the ETFs were piling in easy money and pushing the prices ever higher.

After these lows we would like to see some of these names to stabilise and set a base, from where they can move higher again. This will give market participants some confidence to return.

The Airlines

There has been huge declines in revenues within leisure travel, stemming from the declines in future bookings, as well as the cancellations, with certain corporate travel vanishing all together. These two factors weigh heavily on the group and obviously the stocks have come down significantly, reflecting this short term lack of demand. The question here being the “Short Term”, that is to say, how long is the “Short Term”? And if you compare this with 9/11, the following September traffic was down 38%, October was down 21%, the November was down 18% and it kind of gradually improved from there. It took till February/March of the following year for the recovery (CNBC 10.03.2020). We are hence in unprecedented territory and the events around us will definitely have a negative impact, on the first two quarters of 2020.

The Spring breaks in the US will not see the same momentum in air travel and for summer breaks, most likely it is a wait to see. Airlines have very high fixed costs and therefore they’ll need to reduce their costs immediately, in order to preserve capital. As mentioned before, Leisure travel is down but it is responsive to lower fares. Hence if airlines are able to reduce the fares to their popular destinations, they can navigate through these rough times. The corporate travel, representing the more luxurious portion of this industry has vanished. The announced interventions by the US government, both for this sector as well as the Energy industry is therefore required to curb future disasters.

Oceanic cruise liners are yet another segment under heavy pressure. The Royal Caribbean recovered 7% on the 10.03.2020 only to have lost double digits the day before. The story is not any rosier by the others, i.e., the likes of Carnival and Norwegian.

The only good news for the Leisure industry stems from the energy sector. Oil prices just don’t find a bid here.

The Central Banks the FED – the Silver lining

The massive move from the European central bank and the announced unlimited QE and the Open Ended Asset Purchase from the FED, will in our opinion calm down the market.

In corporate credit, the movements observed since mid-February are 10 x the velocity they had during financial crisis in 2007/2008. Therefore, the dislocations in the credit markets are huge. And this fast movements has had a kind of a magnifying effect on the credit side, leading to the aforementioned unlimited asset purchase program from the FED to stabilise this market.

The Markets are the messenger and the Prices are the message. Looking at the slope of the down turn in the past 3 to 4 weeks, the market is telling us that we don’t have a plan to get out of this dilemma. And the market is sensing that we are caught in a kind of a long-term trap. Because there is no real hope right now, i.e., in the short-term, be it in isolated working, social distancing leading to a continuous operation or any such kind of solutions. Which is heart breaking for the service and manufacturing industry. It all began with travel but now it’s bleeding to all sorts of services industries. Hence we need to see clever government actions in a consorted manner and a new model for work before the effects of this virus are over and the world economy to start functioning again.

Restaurants, Hotels and Airline names have been side lined by an account of God. A majority of companies in these industries are embroiled in this crisis of their own makings. Some would name “Boeing”, as one such example. And although Trump has said that he’d like to tie strings to some of those fore coming packages, in order to make sure that the government get these deals on their own terms. And the question here, in order to rescue BA what terms will the government demand. BA has a huge defence basis and they’re suffering due to the fact that right now the Airlines are not buying any planes. For rescuing these industries is however, wrong to compare Boeing to AIG bank in 2008.

Given these circumstances the markets are functioning well, even if we had great volatilities in the past weeks.

We still don’t have real storm in the system and it’s merely anticipatory as to what might pop-up. Cash flows are being pinched and the market is trying to administer punishment in the correct segment, like airlines, leisure and discretionary and not across the entire broad market. This, however, could not be said on Monday 9^th March, when there was a massive pull-back, across the majority of the segments.

The Watchful Fed – The Liquidity injections by the FED may not really solve the basic economic problems. But in doing so, the FED hopes that the banks will step up and increase their loans to the industry. Banks, however, are not obliged to extend a helping hand. Therefore, FED is and remains the lender of the last resort.

Another good news out of all this is that the inflation will stay low. And hence the risk stemming from the inflation is not there. And that both in the US and in the EU.

Credit Markets

In certain markets, the bid / ask spreads have widened, given how much volatility there is in the market and you have to have that for people to make money. With FED flooding the markets with cash, today, it is a risk management problem and not a liquidity problem (David Tepper on CNBC 09.03.0202). Which means there are people out there reading the risk exposure although there is enough liquidity out there but not all contract sizes.

This is nothing like the past financial crisis, now there is much less leverage in the financial institutions. We are also not worried about convoluted financial instruments. Adding to the liquidity problem. The desks are split-up, because of the coronavirus. The situation will improve, when they are back together again.

People stay home due to Coronavirus but it doesn’t hamper the functioning of the markets and the banks i.e., the markets are still functioning.

The credit markets as bad as they are, have fallen victim to and are hence the symptoms of the disease and not the source of it. This is exactly, what separates this from the last Disaster in 2007/2008, when banks and credit were the source of the issue. Therefore, all these flood of liquidity around the world, including from the ECB and the US FED, are to help those credit markets in the short term, i.e., helping them from default. And that specifically the small and medium sized enterprises.

In recent weeks money has been flowing from corporate bonds funds, as people didn’t want to have anything to do with corporate credit risk (CNBC 20.03.2020). It has all been funnelled into cash like instruments like government money market, while treasury bills trading at negative yields.

Previously, during the crash everything was redeemed for cash. Be it municipal bonds or stocks and that including oil and gold. Hence the sentiment was, just don’t ask any questions and get out for cash or cash type instruments. We need to see activities normalising again. With lows tested and stabilised and have some sense of the correlation between all such financial instruments, before real long-term investors find their way back in the market. One disappointing note here was that the S&P did not hold the 2350 mark, which was not very optimistic.

The Volatility

For those with deep breath, Volatility really does bring up Opportunities. Prices move dramatically in different directions than the underlying intrinsic value of the business. Here one has to keep in mind that the real value of a business is determined by the present value of all cash flow streams. This year’s cash flow and to the future discounted to the present value. Hence, when the prices move so drastically and yes there will be some changes in value, however, it means big value gaps come up, providing an opportunity for truly long term investors. This kind of volatilities provide tremendous opportunity to value investors and bottom fishers. These are groups, who are looking at the price of the business and have the patients and the horizon to take advantage of such situations.

Now the answer to the question, if this is going to be a one quarter phenomenon or not, cannot be answered so easily. The outfalls from this can affect other businesses like travel, manufacturing and so on. Hence, it is difficult to judge if it’s going to be a one quarter or two quarter issue. This will however pass away, like all other viruses, which have come and gone. It might be away within the next 3 months and most definitely no one will still be pondering about it within a year. Therefore the impact should be taken into account and that for the short term earnings. But the intrinsic value of a business is not determined by a couple of quarters. Would you therefore now buy companies that are producing sanitary towels or hand sanitisers and such and that are out of stock to sell now? Well, you might form a trading point of view but not from a value view-point. This is exactly the opposite of value investing. Just because a company is doing well in the short term and that due to an unforeseen phenomenon, it doesn’t mean they will do well in the long-term. As mentioned earlier, one has to look at all their cash flow streams and not just what they’re going to do in the next couple of months.

Politicking of these issues is adding to the volatility of the markets, on both sides of the Atlantic. Although, here in the west the draconian (but effective) measures, adopted in China cannot apply, the governments in the west should find the most effective way to come out of this dilemma. Be it a one month quarantine period or whatever, in order to beat this evil, rather than banning certain Europeans from travelling across the pond, which does nothing but to add salt to an already a large open wound, amongst travel and leisure industries. Doing that will potentially put a base under the markets, creating a foundation.

When looking at Gold, one can say that there is margin selling to facilitate the purchase of equities. Gold was down 4.3% on the 12^th March. May be this is yet another piece of the puzzle, helping a very much washed out market to find some kind of a footings.

Where is Value

On the 19^th February, the peak of the market was concentrated at a few big caps. The duration and how much attrition we will have going forward? It might be a one or two quarter effect but the depth of it might lead to much attrition in the economic down

When it comes to future investments it isn’t easy to decide. What is true however, is that the same over bought sectors that have been purchased and killed during this February and March are the value facing sectors. For example the Financials and that specifically in Europe and certain materials like Glencore. You can look at some of the auto companies too. All these in Europe have been punished since 2018. Hence, if anything the value gap for such companies has widened, as people continue to flock over to stocks where they consider a safe haven, completely ignoring the price of the business.

Within our value investing portfolio, banks and specifically European banks, i.e., the likes of BNP Paribas, Credit Suisse and UBS. The rates situation especially in Europe has been tough for banks. This means that one portion of their earnings, i.e., the lending spreads get hit, due to net interest margin compression. But banks have other levers to pull. And they have been able to pull them. They have hence been growing their non-interest income and at the same time cut costs. Additionally, loan losses have been subdued. Hence, when you look at the whole picture, for the most part, the banks that we are interested within our portfolio universe have been able to grow their earnings steadily. And if we look at a year to date, with some of these, they are up 30 to 35 percent and are trading at multiples of 4 or 5 times normalised earnings and yielding 9 to 10 percent. Despite the hit, we don’t expect the earnings to evaporate completely. Now, if they have been able to maintain this kind of earnings in such rough environments, because Europe has been a good test case as it has had negative interest rates and many developed countries in Europe and yet banks like BNP Paribas have been able to grow their earnings and book value per share, over the last two or three years, despite the low levels of interest rates and hence they have demonstrated that they are able to pull other levers effectively and the market has recognised this. In the meantime, you have a bank BNP which yields over 9% and a French 10 year yield of -40 basis points. Hence to us at SWS here is a huge risk return opportunity with some of these quality financials.

About other constituents within our portfolio, the carnage in the energy sector has been negative however, our positions here are very small and the risk manageable. In travel we have a little more exposure and we have used these situations, in order to increase our exposure to a few of the airline we own. Although one can consider this segment as a capital trap due to their capital intensive operations and longer recovery period.

If we look at online travel however, i.e., the likes of TRIP, a Chinese online travel agency, which in our opinion will be a long-term growth story. This company has very low fixed assets. So there is not a lot of operational gearing with it. Oddly enough it has fallen, however, not to the levels that would make it attractive for us. We will, however, be adding to our positions, at the right price. But others have fallen significantly more than TRIP so this is just one area, which you’d expect to be weak and have glaring value which is not what we’d like to see from a valuation perspective.

On the 12^th march, when the bond market was seizing up and there was a terrible dislocation between the Bid/Ask spreads. There were securities that could not move and when the world’s largest Bond market seemed to be in trouble. The FED came in with infinite liquidity, as put by Steve Liesmann of CNBC (12.03.2020), i.e., as much money as the institutions may want to borrow, on a security, over a period of time. And to stop the total market capitulation with such indiscriminate sales across all asset classes and segments.
This REPO action although does not address the root cause of this crisis, cleared out the short term operations over liquidity and treasury markets. Additionally, it does provide a base upon which the congress and the treasury can build on.

These difficulties caused by the Coronavirus, which is also being spilt across to the energy market is definitely not a financial crisis. However, it can turn into a corporate crisis and hence the reason for FED’s action to move in with the above mentioned REPO agreement. This will allow banks to provide liquidity, whenever necessary, in order not to allow and that specifically some of the companies with high fixed costs, such as airlines and those in the energy sector from going bankrupt.

The remaining question, therefore, will the banks use this liquidity wiser and offer fresh loans to companies in trouble? One can ask if companies in the energy sector that don’t have a future with $18 oil, will have enough breath to make it to the other side of the crisis.

The volatility index rose by 19.37%, on March the12^th reaching levels over 70 points. If the peak, this can be bullish for the equities but is it there now? In any case, it is unlikely that we’ll be talking about the Coronavirus, in three to six months’ time. The effects of which might carry another quarter or two, at which point it will help the markets to recalibrate against their fundamentals.

US vs. the Europe

Although bond yields may not be the beacon for equity valuations, however, when the 10 year touches 30 basis points, there is trouble ahead. With all these uncertainties around us, from the macro, politics and now the virus, we don’t know the faith of the forward earnings forecast. It virtually hangs on a silk string and can go either way. If the northern portion of Europe follows the path of north Italy, it is predestined for a recession and default. That might spell the end of Europe and Euro as we have known it. However, if Europeans are able to manoeuvre around this virus cleverly the markets will rally sharply to the upside, towards the 3^rd quarter of this year.

The Coronavirus has also managed to empty out the streets of New York. The predicted recovery is now U rather than a V- shaped. The question which still needs to be answered is how deep and what is the wide will the U be? With Britain out of Europe, the community has to pay attention that the U does not become to be an L.

Therefore, right now, we are heavily biased towards the US, before entering European mainland. For us the only index in Europe, which provides certain safety is the Swiss Market Index (SMI) rather than the Euro quoted stocks.

Our Forecast

Following a market shock, tremendous trading opportunities arise. And we are now in one such period, where there are fantastic stock picking opportunities in segments with relatively low multiples. These are certain industrials, high tech and even some financial segments. Although we have been picking a few stocks within the past 3 – 5 weeks, it is not easy to pan the bottom, all the time. When VIX was hovering above 60 it was difficult to forecast exactly, but we cannot be more than 5-10% off the all-time lows right now.

And despite the economic setup pre-virus situation, we do find ourselves in a global recession. The question therefore “How painful this recession will be” hangs directly upon the length of time the lock-down will persist, within the developed west world. And although the production in China has already picked up, with more than 60% of the workforce back on the shop floor, the situation will not improve much if the consuming nations, that is the US and the west European countries still remain in lock-down.

Call me an uninformed optimist said Lee Cooperman, this is all about how the virus plays out. I don’t have a medical degree but I have two honorary PhDs. The market at the recent low of 2187 is close enough to the bottom to be called a bottom. If the economic shutdown goes beyond this quarter, I’ll be less optimistic (Lee Cooperman MEGA FAMILY OFFICE Friday 27 MARCH, on CNBC).

In the US, the FED remains the buyer of the last resort. And what makes us more optimistic this time around are the followings:

1. The nature of the downturn – this time it is not a pre-fabricated scam like last times, involving the financial institutions and hidden credit risk components. This is a mere act of God. Therefore if it does not last too long the excellent conditions, which existed previous to this unforeseen situation, do prevail and we expect the markets rally, when the work force returns to the shop floor
2. The FED has been aggressive, trying to be ahead of the curve rather than reactive
3. The US banks have the healthiest balance sheets, they’ve ever had throughout history
4. And last but not least a US president who, despite some of the rhetoric, is very watchful and concerned about the US economy and the markets, like no other before him

The US and ultimately the world economy is driven by the consumer spending. We therefore, need to see some confidence and there will be some pent-up demand, which will eventually be released. We do think that the GDP will turn positive, in the 4th quarter and with better outlook for 2021. However, given the lock-down which still persists, we are looking at three Quarters of contraction and that specifically for the 2-nd Quarter. Hence, we still have some things to get through but we have a good foundation here that will most likely cushion the blow and help us get to the other side.

The trade war with China has been more pernicious than Trump originally thought.

On the surface, the Chinese government does not need to come to terms with the US president, if the terms and conditions are not amicable. And Mr. Xiang is not constrained by elections, like president Trump is. However, we must not forget that despite their enormous reserves, Chinese economy is also suffering under Trump’s pressure and this president does not do business in closed chambers. The US president is trigger happy when it comes to Tweets and for some rather unpredictable. That being the reason, why most of the so called “World Leaders” are not happy with him. This president does not take prisoners and that not even in his own senate. Is he the best president ever or a mere rogue business man, tinkering with the next world war? On the other hand, we must not forget that this is not the first time a US president is crossing swards with worlds mighty. It was Kennedy with Russia in the 60’s and now Trump with China. Although, this war is being fought with economical rather than nuclear weapons. As mentioned before, Trump is a business man and not a warmonger. Therefore he will do all he can, in order to bring stability in the financial markets.

And at the end of the day, the facts is that greed never changes its face … only the players.

Back to Earning Money

The Federal Reserve dropped the Interest rates, yet again by 25 basis points (bps), in September. Is such monetary policy the most effective tool for keeping the US economy alive?

“Keep your powder dry” some shout from the side-lines, thinking that the FED is wasting some unnecessarily. After all, the US economy is in good shape with the lowest unemployment rate ever measured in recent history and consumer is strong.

The resent FED actions are all about risk management, in order to safeguard against the downside risk to the US economy. Which showed signs of slowdown in the third quarter. Hence, the argument for “Keeping your powder dry” can be rather ambiguous. Against all the headwinds, from the Trade talks with China, the Brexit and certain disagreements with Europe, US needs to keep its expansion alive and the consumer on track. And hence the Trump’s call for more rate cuts. Cutting rates too aggressively however, as preferred by some FED members and academics, might level out the inversion of the 10 – 2’s but at the same time it can send the wrong signal to the world as a whole. Indicating that the US economy is in a bad shape.

Therefore, we do agree with the recent measure take by Chairman Powell, who will, almost certainly, reduce the Federal Funds rates for the third time, this year by another quarter of a percent, shaving 75 basis points off the funds rate this year. And as we have learned from Professor Friedman, “Monitory policy acts with long and variable legs”. Therefore, we believe that the effects of the FED’s action will bear fruit starting in the first half of 2020.

Short Term Financing and the Equities

To stabilise the Lending Market, the US FED will conduct daily REPO operations, through to October 10 2019.

Therefore, in such low yield environments, you will have to go with the defensives stocks. Having said that, they are not cheap and exactly for that reason. Defensives provide cushioning for your investments, on the tactical basis and you will have to know why you are buying into these. Such investments are software, healthcare, consumer discretionary and staples, financials and so on. Going forward therefore, any central banks rate cutting is positive for the equities market.

Financials

Although, the US Financials have far out run their European counterparts, they have not been the favourite trade on the street. And as such have taken a massive beating due to the flattening of the long term treasury yields.

The major American banks, the likes of Goldman Sachs, bank of America and JP Morgan are trading at PE ratios of 8.3 to 11.7 (as of Oct. 2019). Which compared to their European counterparts are still very reasonable. The current price to book ratio for the Deutsche bank is 0.2 and that of IMG around 0.7, for UBS it is also not that much higher at 0.73.

In Europe, capable management has been working tediously to trim their business models, like UniCredit and Barclays. But it is a tough stand with the rates ultimately so low and sinking. Hence some capacity has to come out of the banking system here and it will. Because, there is no other way that banks could lend and offer credit to economies that need it.

Therefore, one can assume that globally, right now it is only the US that offers a safe haven. The US stock market and the Dollar are feeling the flow of money to the US of A, as we are feeling the Global slowdown in Europe. We therefore believe that the US banks are too correlated with the moves in the yield curve. Banks have become sensitive to yield curves, to credit trends, to regulatory issues that may happen therefore, there is not much that can get better. Banks on the other hand are fundamentally. It is exactly because of this that investing in banks has become frustrating. Hence, there is not much reason to own them, except those macro trends. As a portfolio manager therefore, there is no much value there and we all know where the yield curve is headed to.

Rates can go lower until they become a problem with respect to deposit costs and credit. The US banks right now are therefore in this sweet spot, compared to their European rivals. They benefit without any of the downside. From a valuation point of view, therefore, the US banks are not that expensive relative to their historical values. At Swiss Wealth Solutions, we take a barbell approach on the banks. On the spread basis, it is very difficult to trade them tactically unless you time it perfectly. In which case, like any trade you can make some money for sure.

The Noise around Recession

The current US economy has a lot going for it. In US we see a relatively strong economic growth and hence we do not subscribe to the belief that the US tax cuts made a substantial difference. However, we do believe that a lot of things look pretty good for the US consumer. Despite this, we do see the sings of weakness that are beginning to appear and the consumers are beginning to feel some pains from the tariffs. And it is also true that only if they get worse, the US might end up in recession. Perhaps, exactly because of this the Chinese delegation is headed for the US, this week. Having said that, the US is far from recession and the fundamentals at the moment are not bad.

And as we mentioned previously, the worry about the inversion, this time around, is mere Technical. In the global bond market, there is up to 16 Trillion dollars’ worth of negative yielding debt. Therefore, where else one can go except to US Treasuries. If the trajectory continues to deteriorate due to the outstanding tariffs, it can destroy the nice picture that is out there now. It is however worth mentioning that first and foremost it is the present US president who cares most about the markets. Therefore, we do not believe that he will allow recession to show its ugly face.

Potentially, there seems to be fluff around the corporate markets but this does not seem to be systematic on the FED policy side of things. With the present US inflation, the two and a half percent FED rate where it was earlier this year, it is nothing like what Volker effect did in the 80s, in order to fight inflation. And we all know that the present FED is accommodative and data dependent.

Recently, Macy’s sales figures came in lower than expected but why is it so important for the US markets that is driving the global economy. And you may rightly ask why?

The answer is Because:

1. The US consumer sustains some 70% of its local economy. Therefore, they don’t need anyone to survive.
2. The US government is one of, if not the most powerful governments in the world
3. The US FED provides the only liable world currency in the world.

Putting 1, 2 and 3 together, Trump in his shine naivety and claim, has made US GREAT AGAIN!

So here we are, the wealth effect and that’s why the FED backed off and that’s why for the answer of when is the next recession, we will watch the S&P500. Where that goes, will tell you where the next recession is.

The Misunderstood Bitcoin

Some call it the digital Gold or is it merely the fool’s Gold?

Let’s look at its definition, according to Wikipedia “Bitcoin is a cryptocurrency. It is a decentralized digital currency without a central bank or single administrator that can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries“.

Any coin in your pocket is there while it represents some value, otherwise can fill your pockets with metal washers and feel wealthy. Therefore, national coins are propagated by a central authority, i.e. the central banks. These authorities use to base their currencies upon a central value holding commodity, i.e. Gold in the past, which is now replaced (for the good or worse) by their GDP, again pointing towards a central value holding authoritative Institution/Administration. Bitcoin, as per its above definition, is everything but a value Currency or a Coin. Even the prehistoric Homo sapiens, who were holding Seashells as an exchange medium, had understood that it had to have a central value, i.e., originating from the sea and hence rare and valuable. With the rise of intelligence and know-how, the earlier Homo sapiens left seashells and opted out for a more valuable commodity i.e., Gold.

Besides all these, a monetary unit that does not replace another will lead to huge Inflation, world-wide. Otherwise, Europeans would not have replaced their local currencies, i.e., the likes of Deutsche Mark, the French Franc and the Italian Lira with Euro. Additionally, if the movements of a currency is not centrally regulated, it will open itself to all kinds of misuse, covert operations and black market transactions. And all that in these days, when abiding costs of regulatory compliance for financial institutions worldwide amounts to millions of US dollars each year.

The same goes for Facebook’s Libra. Although, these clever clogs are trying to link its value to a basket of currencies and hence act as if it is bound to some kind of a value emitting authority, the argument about inflation still holds. And who is the world-wide authority, who will govern the amount of circulating Libra out there? An independent no named authority in Geneva? Why not another one in New York and the next in London? And why are we leaving Frankfurt, Hong Kong, Singapore and Beijing out of this? Why aren’t we setting up organisations emitting currencies for Google, Amazon and Alibaba? The answer, to all these, is simple “BECAUSE NOT THE ENTIRE WORLD HAS GONE CRAZY”. Only a few IT Nerds…

And how much Libra or Bitcoin are allowed to be in circulation? Apparently, they have solved the amount in circulation for Bitcoin by the amount of energy it consumes to produce one and the security behind its crypto algorithm. And hence the next coin, which consumes more energy and is better protected, by even a more powerful algorithm, is to have a higher value and where is it all to stop?

We therefore, advise these Digital primitive Homo sapiens to either pick up a book and read about the basics of the global economy or listen to the likes of Warren Buffett and Jamie Dimon. They will soon come to realise that such digital coins are nothing but the modern Seashells.

We do not deny that such digital methods, routines and algorithms, i.e., the crypto mechanism can be future transport/transfer mechanisms, (for example, providing a safer and faster base for SWIFT). At their present state, however, today’s crypto currencies can never hold any value.

With our traditional logic, unless a crypto currency is backed by a sovereign that will use it to replace a certain amount of its currency, in circulation by its digital equivalent, it will never have any value to an investor.

Beginning of a Goldilocks Period?

They say, “The Trend is your Friend” but sometimes the Trend can also betray you. And perhaps now it’s the time not to follow the trend everywhere. One must be wary of rallies caused by those following dogmatic technical algorithmic regimes. “Buy the Dips and buy the Tips” but then sometimes it doesn’t work and all of a sudden everything comes crashing down. The death of Santa rally, last December was exactly one such period. Are we, therefore, at the beginning of the so called “Goldilocks period”, i.e., sustained moderate economic growth or is this the beginning of a very volatile Quarter, when Asset Managers and clients alike are better advised to keep a very close ear to the ground.

At Swiss Wealth Solutions, we realise that we are all at the edge of a volatile market condition. Our constant endeavour is to illuminate the Market trends and provide guidance and advice for our fellow clients. And we pride ourselves in our Advisory role, specifically in such volatile market conditions. In 2019, complacency will not pay and one really has to ask the sustainability of a saturated US market, pushed higher mainly by a few stocks, i.e., with the like of Facebook, Apple, Amazon, Netflix and Google (FAANG), including Microsoft, Boeing and Caterpillars of this world.

Despite the strengthening of the US Dollar, the global growth continues to weaken and with it the outlook for the stocks. A number of analysts contribute the strengthening of the Euro against CHF, with the new breeze, coming mainly from Germany and to a certain extent from France and Macron. This however, is a very gentle breeze indeed. The economic reforms put forward by Macron is nothing new. These reforms are nothing but a mere copy of what Margaret Thatcher advocated back in the 80s. And we all know the consequences of her actions. Three generations of unemployed in the vast majority of the north and a Brexit. Therefore, these analysts might be right in the short term. The slowdown in the rise of the US FED funds rate, the actions by the ECB are not as effective. And as there is no more patient capital in the system and everyone is looking for yield volatility is to rise.

Chinese reserves are approximately 3 Trillion (i.e., they have bought 3 Trillions of US Treasuries) and if this figure falls below 3 Trillion, the Chinese Yuan will devalue. The US has 19 Trillions of debt and rising and China imports 8 Million Barrels of Oil a day. The deleveraging process in Europe needs to go further. Therefore, extended Austerity periods for Europeans. And that, in particular for south European countries like, Greece, Spain, Italy and Portugal. Not mentioning the rising migration problems in Europe, the Brexit and the recent turmoil in France.

Active vs. Passive Investment

And then there is always the question – will Active management pay-off?

One of the most comical aspect of the above question is that there is a debate at all, about this subject. There is always a lot of noise about the big players like Mr. Buffett or Mr. Ackman, their winnings and trading strategies. The truth of the matter being – by definition “Not all active managers can win”. And as such, there will be winners as well as losers in this game. This does not mean that joining a good active manager is a complete waste of time. There are fantastic active managers, strategist out there and for this, Bill Sharp framed it beautifully. He basically pointed out that the Market is Capitalisation-Weighted, i.e., weighted according to the total market value of their outstanding shares. The indexes and the index Funds are also capitalisation-weighted. Pull them out of the portfolio and what are you left with, the same portfolio that’s what the active managers own. The portfolio therefore can’t beat the Index Fund. Therefore, collectively they cannot win. And hence when people talk about, this market is good for active manager and that market is bad for the active managers, they are talking a lot of nonsense. What one can say, is that during volatile months it should be expected that active managers get more out of the market than passive ones. And this is due to the fact that during turbulent times Index Funds and ETFs average out the winnings within a group of stocks, where as a smart active manager can bet more on the winners than the losers, within the same group and hence be able to harvest better winnings for their clients, than a passive index can.

Growth Stocks

Soon after the election of Donald Trump, everyone predicted a 3 – 3.5% economy, however despite low unemployment figures, the inflation is not moving and the US is still a 2% economy. Despite their average 100K plus job figures each quarter, the wage growth is just not there. And we all know, that stock prices don’t tell the whole story. And certain stocks, despite their positive revenue figures, like Wall Mart, have their stock price slashed. And it can be similar with the likes of Facebook, Apple, Amazon, Netflix and Google (FAANG). This brave new future, that everyone is postulating for is a lot of these momentum stocks, where you can have the same kind of pull back happening.

And then we have Tesla. Elon Musk showed off the first Tesla Model 3 vehicle and it is promising to be Apple in the cars industry with great opportunities. But aren’t they going to be impacted by component shortages, just like Apple was, i.e., with their shortage of their battery packs- the Tesla story is certainly a very interesting one, with capitalisations well above a lot companies with healthy revenue. And this, for a company which loses money with each care sold? And even if they did have the first mover’s advantage, which may not bear fruit. After all, the competition from Europe and China are not sleeping. This is what capitalism does, it knocks off the exceptional and levels the playing field. Therefore, a company that pioneers a certain market often has a limited time to bask in its first-mover advantage, before the competition sets in. Unless one can capture the users imagination and set up a trend. And one must admit Elon has done a fantastic job, in this respect. However, one mustn’t forget that the in this car industry where European rivals like Volkswagen, BMW and Austin Martins of this world are engaged, it will be difficult to sustain. Not mentioning a number of our Japanese competitors like Toyota and the new Chinese arrivals.

Dividend stocks

On the back of rising interest rates, there can be an opportunity for these stocks, because the interest rates may not rise as fast as what people think. The economic data out of the US is mixed at best and the FED has already signalled a very gradual rather than being more hawkish on the interest rates. There is simply not enough inflation in the US economy right now. With energy down 4 – 5% below USD 50 a barrel, last year. The dividend stocks get crushed when interest rates rise significantly, but we do not believe interest rates will rise significantly more this year, which is positive for dividend oriented stocks. On Pay-out, Jamie Dimon, CEO of JPMorgan, explained that, He would like to spend more time to grow the company organically and it is not the lack of capital that is hindering more loans. But if asked, “If I rather use the cash to buy back stock or grow the company, I’d say grow the company”. And some people think that banks are buying back stocks because they have no other ideas. He went on to explain the fact that “Loans are constrained by other factors and not right now by Capital” and he explained if a lot of things were different in the past 5 years he would have much rather put that money in use growing loans, in order to fund companies in need, in the American society rather than buying back stocks.” Jamie also believes that the US banks will go back to financing the economy and on the 8.8.2017 he mentioned that there can be a trillion USD more mortgage loans helping America to grow and in his belief, that’s where the government should be focusing and not the pay-outs.

Banks Lend Long and Borrow Short, hence steepening yield curve allows them to make a lot more money. With the flattening of the 10 year yields, it is obvious that the bank stocks would suffer. Earlier this year, Brian Moynihan of Bank of America pointed out towards technical flattening of the 10 and the 30 year yields. However, that as he said “This is technical” and does not alter the fact that as such the economic health of the country is still intact. As such, consequently banks whose main business is lending, like the regionals, will experience a flattening of their earnings. The story is quite different for the large banks, such as the Goldmans and Morgan Stanleys of this world. Although, all banks are providers of capital to the market and households, large banks are also engaged in other activities, like M&A, Wealth Management, Trade execution and last but not least Proprietary Trading, which although has taken a knock in the past years, is still a significant earnings revenue in their mix of activities. But some point towards the fact that trading with Fidelity and JP Morgan is virtually free. You have money managers under pressure. The financial stocks were trading at 2 x book value, i.e., at some historical lows (65% below S&P 500 average), towards the end of last year. As pointed out by the CEO of Credit Suisse, with such cheap valuations banks start to buy back their own shares.

Consumer Staples

The consumer staples brands, although being hammered by Amazon, might start peeling off their brands and start selling some of their business in the market place. Certainly the financials are going to be under pressure if interest rates don’t rise as much as some people think. But there are other opportunities out there. If the S&P 500 is close to all-time highs or close to its all-time highs that doesn’t mean that all 500 stocks have risen at the same rate or amount as the top performers like Apple and Tesla. And this doesn’t mean there are no other opportunities and that in particular again in the dividend space. Another pace, which has been beaten down significantly is Energy and although a lot of people have given up this space, there are a lot of opportunities out there with the likes of Chevron, Exxon, BP, BHP Billiton Royal Dutch Shell, Occidental petrol and Phillips 66, that are not only well run but are paying a descent amount of dividend for waiting.

The Bond Market

Is there a bubble in the bond market – Will there be a problem, when the FED normalises its balance sheet? Jamie Dimon doesn’t call it a bubble but as he said, however, he wouldn’t be putting money in the 10 year Sovereign debt, anywhere around the world. And the reason is simple, US alongside EU have gone to QE1, 2 and 3 and now everyone, led by the US is reversing it. And in our view the FED is doing the right thing, that is, raising the rates and telling all that they’ll be reducing the balance sheet. The likely outcome is that, it will be fine particularly when the American economy is doing well. Therefore, the FED’s action in the face of the economy, will not be that disruptive. Only caveat being that, folks out there have to be cautious. Here we want to point out that, it can give rise to volatilities simply because we’ve never had a reversals of this scale before. And when ECB starts the same program, no one can predict the future and our view is that you cannot make something certain that is not certain. That is perhaps why the comments out of the Chairman of the FED have been rather dovish, while monitoring the economic figures in detail. Janet Yellen, previous FED chairwoman warned the markets of the outstanding corporate debt and that it could be the next bubble for the markets. Having said that, the estimates go where the stocks follow. And where there is economic deceleration, stocks can set to become cheaper.

The big questions therefore, can Donald Trump deliver the promised tax reform, during his first term in the office? And the answer is that, it is critical that he does. The US economy cannot work if he doesn’t. And a lot of CEOs, who are engaged in a lot of capital expenditures are getting involved, in order to get the agenda forward and directly and indirectly they are creating 30 or 40 million jobs. The major initiatives are hoping that it will come rather sooner than later. Although, we are starting to get nervous about the economic growth under Trump’s administration, the fact is that the American economy is putting 150 million men and women to work every quarter. And it might be shocking to some, to understand that despite the GEO politics, sometimes and in spite of Washington that resiliency of the systems at work. Most people don’t go to work thinking about Washington. They go to work to put their kids to college, to put food on their table and stuff like that. Therefore, so what if some saying, is that the US is growing at 2%, in spite of that Gridlock.

One must also remember that the economy is not always synonymous with the markets. And the Valuations are terrible indicators of short term market performance, if you look at the earnings. If you look at the markets and that specifically at the International Loan Markets, they are trading at half their valuations, as the US Markets. Of course, no-one knows what’s going to happen in the next 3 to 4 months, with all those uncertainties out there. But if you look at the international markets, they do look to be oversold, relative to their valuations. This time it can be the FX crevice, which would be looming out there. Is the market under-pricing Risk, since the March of last year? At Swiss Wealth Solutions we are not sure. However, as a whole the market, we assume, knows more and believe it to be correct. Well, as they say, “No one knows, till everyone knows”.

And with the China talk, any agreement is going to be better than no agreement. And that specifically for the industrials and everyone else who has a large footprint in China. That is, the likes of Boeing, Starbucks, Tesla and even Dunkin’ Donuts. With the recent wage rises, coupled with some of the best numbers in the unemployment figures, it seems as if the US consumer has never had it better, in the recent US history. And knowing that close to 70% of the US economy is about the consumer, it paints a very bullish economy and the stock market. Last but not least, no one can deny that Chines consumer spending is also rising. It is therefore a mere matter of time when they will overtake the spending power enjoyed by the US consumer today. Therefore, looking at the sheer number of population out there, one can only be thinking of Goldilocks. Although, there may be some road blocks along the way.

The European Union

And finally, as far as Europe is concerned, there can be some idiosyncratic risks out there. Some of the balance sheets of the European banks are still bloated with non-performing loans. Hence, it might get in a situations where the government or the ECB might have to intervene. More importantly, however, if you look at the return on equity for European banks, it is starting to rise and we are seeing pretty steep slopes. Hence, in terms of Europe and the banking industry, we believe that the worst is over. This doesn’t, however, mean that there are no pitfalls out there. The main key to sustaining growth in Europe is the credit growth, most of which is coming from the banking industry. Therefore, the loan growth will be the fuel for the economy on this side of the pond. This is, in order to sustain expansion and the banks are well poised to deliver it here, only if it weren’t because of Brexit! And all this, rests on the shoulders of Mario Draghi and his resilience in leaving the interest rates unchanged. The recent rise in the US dollar, despite of the FED’s walk-back on the interest rates, provides a relief for Euro. However, if Euro were to appreciate against the US dollar, it can lead to detrimental results for the export industry in Europe.

AT 20800, the Dow Jones Industrial average has had a year to date price return of around 5.3%. This price-weighted index, however, is not a predictor of what is yet to come. The Stock market is priced off of Earnings and the multiple of Earnings. The average multiple forward PE ratios in US right now is around 18 and therefore the US stocks are richly valued. We don’t see the revenue growth to support the earnings growth. Therefore, if the US Tax cuts are postponed the market will pull back in a dramatic way. And there might be a catch-up with Legislative realities, which cannot take place in such short time. And these, even with government forecast are postponed till August 2017. That’s why one can look at Europe.

Some perhaps are euphoric because they remember the Bull markets during Regan and Clinton, when there were huge legislative actions and they got things done very fast. May be Gary Cohn, the chief economic advisor to President Trump, will be the next James Baker in Reagan’s era.

The truth, however, is that you cannot get the corporate profits without the GDP growth. And GDP growth is directly related to the cost of labour, which without immigration is difficult to contain. At the same time, President Trump is trying to put the dampers on immigration, in order to boost employment for the US Americans. Now, if you only look at the GDP, the US productivity numbers are fine. And in actuality you need more people to lower the cost of production but as mentioned before, this is contrary to the promises made by the present President. With not enough people coming in the workforce it might be difficult to reach the targeted 3% growth in GDP.

Another area in President Trump’s focus is banking. Donald Trump has an enormous focus on business and costing. And you can’t grow unless your banking system is expanding credit. With the low interest rates the US is driving with one foot on the gas and with the present regulatory overlay with one foot on the break. Therefore, Mr. Trump is correct to get rid of the unnecessary regulations, which have done nothing but to reduce the opportunity and increased the cost of borrowing. With increased credit at the present rates the companies will be intensified to grow.

But what Trump is also hoping for is for Europe to remain an absolute mess, keeping US margins very attractive for foreign investors. The US economy under Trump has a lot of leverage because a lot of investors don’t want to be stuck in Europe, where the wheels have never been put back on.

Europe might be a disaster, when looking at its political landscape, certain debt expenses and some of the banks. European PMI numbers, however, tell a very different story with some growth. Hence, all these headline noise about the effects of Brexit and Breakup of European union may never happen. Europe is not breaking up and certain European companies are more attractive compared to their US counterparts. European companies are having more earnings growth. Europe on average trades at 1 x PTBV, i.e., the tangible book value, whereas the US is trading at twice book value. Therefore, if there is any positive news out of Europe the stocks will rally massively. At the same time due to the higher multiples of the US stocks, any delay in any of the legislative decisions to lower the taxes or delays with the regulatory easing, the US stocks have more potential of leaving investors with greater share price losses.

The biggest threat in Europe right now can come from a sudden slowdown in Monetary Easing. If German inflation picks up and the European Central Bank (ECB) puts the breaks on growth. Ultimately, however, Germans are aware of the fact that a slowdown is detrimental for the rest of Europe and its cohesion for a strong Union. A sudden slowdown will destroy the marginal European nations like Italy, which has not had any growth for the past 10 years and they are desperate for any kind of growth in 2017.

As far as the currencies are concerned, Inflation & Deflation are one and the same. During inflation the currency loses value due to market forces, the prices inflate and rise faster than what is usual. Hence the government moves in and puts up the interest rates, in order to squeeze the market. During Deflation, however, it’s again the governments who push down the value of money, in order to get the markets started. And with both these scenarios, as the value of the money goes down, Gold becomes more attractive.

At Swiss Wealth Solutions, we spend a lot of time analysing the global markets with investments in global business and listening to today’s most important leaders. It is crucial to understand the present markets, in order to be prepared for tomorrow. Right now, as previously mentioned, compared to the growth in productivity and the earnings, valuations are high in the US. Hence, one needs to be cautious. The S&P and the Dow have broken all-time records on low volumes. Looking at the charts, the markets have been meandering with no real conviction. And therefore, you need to look at the balance sheets, and the earnings, in order to seek value. At Swiss Wealth Solutions, we are therefore agnostic as to which side of the Atlantic we find value and our trading strategies right now cover both the US as well as the European markets. There are however strategists who prefer emerging markets. Given the global uncertainties right now, we advise our clients to stay closer to the US and Europe and not to venture too far in search of yield. Because you cannot get more yield without taking even more risk.