Blog

By Jolette Persson, Hottinger Capital Partners

To ease the economic slowdown caused by the pandemic, governments around the world are announcing their versions of a stimulus package coupled with interest rate cuts as much as half or more. Despite this, markets have continued to sell off. We know that monetary policy operates with a lag (typically 6-12 months) so we were unlikely to see instant relief in markets or the economy, but coupled with fiscal measures, which have more of an immediate effect, this should help to ensure business continuity as navigation through difficult waters persists. We recognize, however, that neither type of measure will prevent a recession from happening, but it’s hoped they will support liquidity and provide a floor to the inevitable losses in the current climate.

The US +$1tn stimulus proposal plan recently announced is designed to cushion the impact of the slowdown on households and businesses and will include deferred IRS payments of $300bn and $1,000 cheques cut directly to Americans. The UK has issued a smaller – but nonetheless large – emergency rescue package of £350bn for businesses, which will include government grants for retailers, restaurants, and pubs in need. Further discussions are currently taking place around potential support packages for airlines – which at the current rate are widely forecasted to go bankrupt by May – and airports, to be announced in due course. In response, sterling has experienced what appears to be its worst sustained selling period in 35 years. The sell-off reflects the fact that investors are coalescing around the comparatively safer USD and showing a lack of confidence in the UK government to tackle the current crisis. It is also unclear how the UK plans to finance its emergency package, which will most likely require heavy borrowing. Even so, exactly how effective this will prove to be is yet to be determined, particularly as fiscal policy response to the coronavirus so far has been relatively benign. It will also come down to how successful the virus containment measures prove to be. [i]

At the time of writing, China has – for the first time since the start of the virus outbreak – reported no new local infections, showing that its actions to contain the virus have been effective. [ii] That said, this has been achieved at substantial liberal and economic cost, and furthermore the hiatus in new infections does not guarantee that there won’t be a resurgence as citizens return to work. The suspension period has pushed many businesses into bankruptcy, and as China sets off for a rebound in production, we do not expect this to happen at a fast pace, especially given the reliance on European business activity which seems to be decelerating by the hour. [iii]

In the UK alone, the hospitality, tourism, leisure and retail sectors have all suffered an unprecedented drop over the last week. Many businesses have decided to close their doors for the foreseeable future, which has to led thousands of workers losing their jobs overnight. As the government advises UK citizens to stay away from social gatherings, restaurants and pubs without officially forcing owners to close their premises, we will undoubtedly start to see more businesses file for bankruptcy in the absence of better fiscal support. One could describe the situation as catastrophic, and it leads us to expect a plunge in employment rates by the end of this quarter. The hospitality industry alone employs more than three million people across the country. Retail – already a struggling industry which saw a record number of store closures last year – is on pace to double that this year not just in the UK, but globally. [iv]

We are yet to see these drastic changes showing up in the official data, but it certainly feels inevitable that output across Europe will experience a sharp decline in the first quarter of 2020, triggering a linked recession in larger European economies. The severity of such a scenario will depend on the actions taken by policymakers next. So far, despite recent efforts, policy response does not nearly make up for the cost of the epidemic, which at this rate is estimated to exceed $3tn as it continues to shave off global GDP growth. [v]

Monetary stimulus continues to roll out. The European central bank (ECB) recently announced that it would buy €750bn worth of bonds to improve liquidity and decrease the cost of financing to make it easier for eurozone governments to support domestic businesses. Shortly afterwards, the Bank of England announced billions of pounds’ worth of its own bond purchases and proceeded to cut interest rates once more, which brought its benchmark rate to 0.1%, a record 325-year low. Though bond markets welcomed this news, we continue to see a lack of fiscal policy to follow. Businesses close to bankruptcy may not exactly be jumping at the opportunity to leverage up their balance sheets when business sentiment is at rock bottom. [vi]

Finance ministers need to provide liquidity support through fiscal policy to assist business owners in paying wages and keeping their employees on the payroll. Such efforts would include granting reduced working weeks (such as ‘Kurzarbeit’ in Germany), parental pay schemes as schools continues to close and deferring the collection of VAT and payroll taxes until the crisis is over. The aftermath of this crisis will be different from that of the financial crisis in 2008, as consumption then took longer to recover due to unsustainable debt levels. This time around, we expect manufacturing to pick up fairly swiftly in a “V-shaped” recovery. All social consumption, however, will first have make up for lost time, and as such is likely to experience a prolonged recovery period.

[i] https://www2.deloitte.com/us/en/insights/economy/global-economic-outlook/weekly-update.html

[ii] https://www.nytimes.com/2020/03/18/world/asia/china-coronavirus-zero-infections.html

[iii] https://www2.deloitte.com/content/dam/Deloitte/dk/Documents/about-deloitte/Corona%20impact%20monitor%20-%20Mar%202020.pdf

[iv] https://www.bbc.co.uk/news/business-51923804

[v] https://www.bloomberg.com/graphics/2020-coronavirus-pandemic-global-economic-risk/

[vi] https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1~3949d6f266.en.html

 

By Tim Sharp, Hottinger Investment Management

If we look back to the end of 2019, it was clear to us and our advisers then that the fundamentals underlying the financial markets were fragile and potentially vulnerable to an unknown shock that questioned the market’s expectation of future growth. We were advocating for caution due to the potential for a global recession as a result of tight monetary policy and a lack of the central bank stimulus necessary to maintain positive global growth.

The contagion of the coronavirus outbreak may have laid bare the over-valuation of financial markets and drastically altered the macroeconomic outlook for this year. As we see it at present, there are four main unknowns: [i]

It is unknown how far coronavirus cases will spread – both in terms of number and geography – before the global peak is reached. Statistics from 12^th March Absolute Strategy Research (ASR) would suggest that China is the only country, out of the 110 globally with registered cases, that has seen a levelling off of new cases. Asia (excluding China) is still seeing the number of cases increasing, as are Europe and North America, which means that the virus is not contained at this time. The best-case scenario based on the collated data is that the virus is brought under control during the month of April, when the economic fallout of the outbreak can be assessed.

At this time, the second unknown is consumer behavior, whether it is stockpiling during the epidemic or the willingness to return to normal consumption after the virus has been contained. Evidence would suggest that it took consumers 6 to 9 months to return to normal behavior after SARS, which calls into question the likelihood of a V-shaped recovery in the second half of the year.

The third unknown relates to the extent of the supply-side chain damage that is being sustained during the outbreak. For a company to change its parts supplier temporarily during a period of difficulty is one thing, but to have to implement such a supply chain adjustment permanently has more long-term consequences for the global economy. The impact could be similar to that of the US on-shoring that took place following the tax breaks in 2017.

The final unknown is the effectiveness of the central banks’ and governments’ policy response that has so far seen significant monetary policy easing from the US, Canada, UK and Australia, as well as an increase in QE from the European Central Bank (ECB). We have previously documented our belief that the strength of the dollar is fundamental to the growth of the global economy, and we feel that it may require a coordinated fiscal response outside of the US to stimulate the wider global economy. The strength of the Euro vs. USD, for example, will only be overcome in the long-run by employing a policy response that is wider-ranging than cutting rates and increasing TLTRO (targeted longer-term refinancing options) spending.  At this time, however, the countries of the eurozone are not in agreement as to the best way forward for policy coordination.

The breakdown of the OPEC+ discussions has laid the foundations for a possible oil price war instigated by Saudi Arabia and largely influenced by the actions of Russia. The immediate fallout of a 35% depreciation in the price of Brent Crude from $51.60 to $33.30 is an indication of the likely result of there being no supply quotas in place for the major oil producing countries. The result of a prolonged oversupply of oil, other than a potential $20 per barrel handle, could have a more significant effect on the global economy than even the coronavirus.[ii]

The fiscal breakeven Brent crude oil price for major oil suppliers provided by Absolute Strategy Research (ASR) makes for interesting reading and there is potential for two effects to unfold[iii]. Firstly, Saudi Arabia has a fiscal breakeven of $84, despite having one of the lowest costs of supply. In previous periods of low oil prices, markets have seen sovereign wealth funds selling down liquid assets such as equities in order to maintain the domestic agenda. We have seen no evidence that this type of action has happened as yet, but we remain alive to such a scenario of forced selling. Secondly, the figures show that Russia’s fiscal breakeven is $42, while alternative providers such as US shale and Canadian oil sands having breakeven prices of around $50. This clearly leaves Russia with a margin to put pressure on the new oil producers in countries that have been thriving on high oil prices arguably created due to the US policy of imposing sanctions on Russia and Iran. It will be interesting to see how this unfolds, particularly if the oil price stays at a low enough level to lead to the shuttering of US wells.[iv]

China is seeing the beginnings of a return to normal activities, with reports calculating that the economy has returned to 50% of its pre-lunar new year capacity when the rest of the world is yet to see the peak impact of the virus.i Assuming that other countries have to follow a similar or even longer timeline to China, it is likely that estimations that the outbreak will persist well into the second quarter may prove to be accurate.

Most developed market equity indices have moved into bear market territory (i.e. fallen more than 20% from the February 2020 record high) suggesting that the financial markets are beginning to price in the possibility of a global recession in 2020. The core view that we have seen is that the 1^st half of this year will see a technical recession and a peak in the epidemic, leaving the global economy to recover during the second half of the year. The downside risk to this scenario is that the virus containment is not as successful as currently expected and affects activity in the third quarter as well. This may then start to have a significant effect on the supply-side, impairing the ability of the global economy to bounce back quite so successfully and pushing the global economy into a deeper recession.i We are not so sure that this scenario is priced into equity markets, so we still remain cautious of calling the bottom of the market here.

The upside scenario is that the containment timeline could be correct and coordinated stimulus from major countries including China and the US may be effective enough to generate a strong recovery, however, at this time we do not have enough information to make informed decisions.

Any economic statistics that have been released recently relating to pre-virus contagion are largely irrelevant, so markets will remain volatile until fundamentals can be evaluated properly and we expect to see further earnings revisions.

[i] Absolute Strategy Research – Contagion Effects, 12 March 2020

[ii] Capital Economics – Oil price slump not a positive for global economy, 9 March 2020

[iii] Absolute Strategy Research – Investment Implications of possible Covid-19 Scenarios, 10 March 2020

[iv] Absolute Strategy Research – Oil shock adds to Coronavirus crisis, 10 March 2020

By Jolette Persson, Hottinger Capital Partners

There has been a clear spike in corporate profit warnings in the last three weeks. Apple was one the first of many US companies to publicly cut its revenue outlook driven by China’s slowing economy which in recent weeks has dampened further due to the spread of the coronavirus. The profit warning was narrowed down to an anticipated decline in iPhone sales in China and slowing pace in production. [i] Microsoft in parallel also issued a profit warning statement, particularly focused on its Windows and Surface businesses, due to supply chain disruption caused by the virus as the segment relies heavily on production operations in China. [ii] Similar to Apple and Microsoft, companies across geographies and industries are lowering their first-quarter forecasts, most notably in luxury goods, automobiles, leisure, airlines, technology and banks. Just in the UK, more than 100 UK-listed companies have now warned its investors about potential impacts of the coronavirus on their business. [iii]

Concerns over further escalation extends to global governments and central banks. Most recently in an attempt to soften the blow experienced in the US economy in the short-term, the Fed on the 3^rd of March decided to reduce rates by 50 basis points. [iv] Bank of England governor, Mark Carney, shortly after signalled that it was also prepared to cut interest rates in an attempt to keep current supply chain disruptions temporary as opposed to a permanent impairment in supply. [v] Economists are not ruling out the possibility of a global recession, especially if global growth in 2020 disappoints from what is already a relatively modest forecast. The recent decline in the oil price, which to a large extent reflects the deterioration in Chinese consumption, has aided our concerns about the global economy. Particularly, as we remain in a close to zero inflation environment. Though, it’s worth emphasising that there are yet clear signs of real economic damage, with unemployment rates left relatively unchanged since the beginning of the year, and consumption still in decent health outside that of mainland China. If a recession was to occur, it will likely hold little resemblance to our last seen financial crisis in 2008 (shockwave in demand) as banks went bankrupt, home prices plunged, and stock markets bottomed. This crisis would more likely evolve around a lack of supply, leading to a slowdown in economic activity.

So far corporate profit warnings have been concentrated around companies whose business is fed by a global supply chain. Companies without direct links to the disease have not experienced the same correction in revenue forecasts and/or share prices,  although, potentially, yet to be announced. We will continue to monitor this under the assumption that a global recession may not be as imminent a threat if this remains unchanged. In the meantime, there are some sectors with certain business models that might even stand to benefit from the current “quarantined” situation. With companies and governments encouraging people to avoid travel, work more from home, and self-isolate, companies catering to consumption through domestic internet services such as Amazon, Netflix, online education, online gaming and other home entertainment could be rewarded. These assets might serve as short-term stress reliefs in portfolios. What we as investors are more concerned with, however, is the long-term story.

There is a possibility that the market is overreacting, particularly in areas outside of Asia where the spread of the virus continues to remain relatively low and with stark measures in place for containment. Yet, major indices worldwide have lost trillions of dollars in value over the last few weeks. That said, however, we feel that perhaps markets may still be overvalued with some way to go before getting close to their intrinsic value.

When studying the effects of previous outbreaks of respiratory viruses like SARS and MERS (see figure 1), markets remained volatile in the short-term followed by a longer recovery period. With that in mind, although we do not think we have seen the bottom of the market yet, this could serve as an attractive inflection point, though it is still too early to tell. Markets will typically start to price risk correctly following a period of unchanged fundamentals. Potential positive catalysts  include the number of infected people outside of the mainly infected areas decreasing, suggesting that the virus is getting contained, workers returning to their regular schedule and production activity in China picking up. As we are yet to see any of this, the situation remains volatile and impossible to predict.

[i] https://www.ft.com/content/ab59aac6-51ce-11ea-8841-482eed0038b1

[ii] https://www.nytimes.com/2020/02/26/technology/microsoft-coronavirus-earnings.html

[iii] https://www.cityam.com/132-uk-companies-issue-coronavirus-warnings-as-ftse-100-spirals/

[iv] https://www.wsj.com/articles/federal-reserve-cuts-interest-rates-by-half-percentage-point-11583247606

[v] https://www.ft.com/content/2b0dfbc6-5d4d-11ea-b0ab-339c2307bcd4

 

By Kevin Miskin, Hottinger Investment Management

In last week’s blog, we noted that the global economy could enter recession within the next 12 months and urged caution as the risks to financial markets were weighted to the downside. At the time, however, we believed that markets would remain relatively benign until closer to Easter.  If, as Harold Wilson famously once said, “a week is a long time in politics” then it can seem an absolute eternity in investment markets.

During the first three weeks of February, the S&P 500 climbed to an all-time high and European stock markets reached levels not seen since the financial crisis as the broad consensus held that the global economy would avoid recession in 2020. Headline PMIs had troughed in October and PMI new orders were improving. US and European company earnings for Q4 2019 had exceeded expectations and high single-digit earnings growth was forecast for this year. There was a further assumption that as long as the coronavirus could be contained within China, the impact on global economic growth would not be too severe. However, with news of the virus spreading around the globe (notably in Japan, South Korea and Italy) towards the end of the month, this base case scenario was shattered.

The market reaction was both swift and severe as global equity indices fell into correction territory (a downward move of 10 per cent) in the shortest time period ever. For February as a whole, the MSCI World Equity index fell by 6.7%. The UK led the declines with the FTSE100 falling by 9.7%. Elsewhere, the major US, European and Japanese stock markets fell between 8% and 9%. Ironically, China became a port in a storm, with the Shanghai Composite index appreciating by almost 5% after markets returned from the Chinese New Year.

In the early stages of the coronavirus outbreak, Asian equity markets and cyclical sectors, such as transport, understandably bore the brunt of the selling. However, more recently it has been the ‘winners’ of last year that have come under pressure, including US Equities, technology, growth and quality.

The increasing chances of Bernie Sanders becoming the Democratic presidential candidate has also cast a pall over certain US sectors. His radical agenda includes breaking up banks by reinstating the Glass-Steagall Act, imposing a financial transaction tax, capping interest rates on consumer loans, increasing taxes for the super-rich and cancelling student debt.

In commodity markets, Brent Crude suffered a decline of 16.5% to $50, having traded at $70 in early January. Oil consumption in China has fallen by a quarter since the outbreak of the virus. Saudi Arabia is attempting to stem the price leakage by calling for a concerted cut in production of 1 million barrels per day, of which it has offered to bear the lion’s share. However, at the time of writing, Russia appears reluctant to fall in line. Gold initially fulfilled its role as a safe haven, rising to a 7-year high of $1,688, but ultimately gave up its gains to end the month in marginally negative territory.

The ultimate safe haven asset proved to be long-dated government bonds. Over the past two decades, the negative correlation between equities and bonds has hardly changed, despite ever-lower yields. The reason is that it is not the level of yield that provides the hedge, but the sensitivity to the change in yield, which comes from the length of duration. Therefore, even with today’s low/negative bond yields, having some duration in portfolios mitigated some of the losses from the equity market correction. The yield on the US 10-year Treasury closed the month at a record low of 1.15%, down from 1.51% at the end of January, representing a capital return of 3.3%. The UK 10-year gilt fell by 8 basis points to 0.44% and the German benchmark bund yield fell further into negative territory, ending the month at –0.61%.

At the short-end of the curve, the US 2-year Treasury yield has fallen below 1%, implying that the US Federal Reserve is expected to cut interest rates by 75 basis points by the end of the year. Meanwhile, the 30-year US Treasury has fallen to a record low of 1.7%, which suggests investors have become concerned about the sustainability of any longer-term recovery.

At the time of writing, the spread of the virus is accelerating outside of China and analysts are in the process of downgrading their predictions for global growth and company earnings. A Bloomberg poll of analysts has global growth predicted to fall to 2.8% this year, which would be the lowest rate since the financial crisis.

According to Absolute Strategy Research (ASR), we are at a crucial stage in the coronavirus narrative. During previous episodes when bond yields and equity markets have fallen to this extent, the relative valuation between the two asset classes has seen investors move back into equities. However, should risk assets fail to rebound during early March, ASR cautions that investors may start to focus on the potential for further supply chain disruptions with negative implications for global markets.

The disruption to global economic activity for Q1 may have now largely been discounted by markets. The question is whether the virus outbreak will be contained by the end of March or whether it will expand in terms of duration and geographic reach.

On the positive side, the slowdown in growth could yet prove to be short-term. In addition, recent political shifts towards anti-globalisation could ultimately prove to be beneficial; in Europe, companies have been stockpiling ahead of Brexit, while in the US companies have been forced to overhaul their supply chains as a result of the trade war with China. There is also hope that the spread of the virus could be curtailed as the weather turns warmer.

We believe a more likely scenario is that the disruption will continue into Q2 and result in a tightening in financial conditions. Central banks will likely respond with even easier monetary policy and governments may open the fiscal taps, which could provide short-term support for risk assets.

We were relatively cautious entering February and reduced equity allocations where appropriate as the virus spread beyond China. In the current environment, we will monitor developments while coronavirus fears continue to obscure the outlook for global markets until such a time as there is more clarity.

By Tim Sharp, Hottinger Investment Management

Global monetary conditions remain tight and the risks for financial markets are weighted to the downside. We continue to believe that there is a tangible risk of global recession within the next 12 months and will maintain our cautious stance in the near term.

The coronavirus has started to affect supply chains, underlining our prediction that the next likely inflection point will be around the beginning of the second quarter. This will coincide with first quarter reporting, the selection of the Democratic candidate for the US Presidency and the forward-looking tendencies of equity markets to be focusing current economic forecasting on Q420.

There is now evidence, as reported by Apple Inc, that the coronavirus is affecting global supply chains and is predicted to have a significant effect on Chinese Q1 growth and the wider prospects of the Asia Region. Japan is now predicted to enter a technical recession in the middle of 2020 – this is based on the slowdown in activity with China, South Korean President Moon Jae-in’s call for “emergency steps” to support the economy and Singapore’s unveiling of a $6.4bn virus-related stimulus package.

We recently highlighted in our China / India article that a 1% drop in China’s GDP will affect global growth by 0.2%, so the fact that the outbreak is having a magnified effect should not be surprising. However, it may only suppress spending in the short term – causing a spike in demand once the worst of the outbreak has been overcome, instead of causing longer-term damage to global growth prospects. It could be argued that equity markets in particular are discounting a v-shaped recovery in trade, growth and earnings, however, equity valuations are looking over-extended, the buy-on-dip mentality seems to be firmly in place, sentiment remains positive and few look as though they are positioned for recession[i].

We feel that current forecast earnings in developed markets over the coming year are too high and open to significant revisions, and we remain sceptical about whether the current levels of central bank stimulus will be enough to boost the global economy, so we believe a threat of significant equity drawdown remains. A squeeze in profit margins has been the reason for the fall in corporate profits over the past year, as wage growth has strengthened across developed markets. The consensus expects 9% EPS growth over 2020, which looks optimistic to us. Absolute Strategy Research (ASR) expects global EPS to decline 4%, with declines of 6% and 9% in the eurozone and US respectively[ii]. EPS growth remains underpinned to an extent by share buybacks that have seen company balance sheets change exponentially as debt is raised to buy back shares. According to Julius Baer, S&P 500 buyback peaked in 2019 at approximately $1trn but is likely to stay high while the cost of equity remains substantially above the cost of debt and the economy continues to expand[iii]. However, fundamentals cannot be ignored indefinitely and a sustained squeeze on profits should be reflected in stock prices eventually.

A strong dollar is a symptom of tight global monetary conditions. There remains a reluctance of international banks to lend US dollars due to the interest differential and it is unlikely, in our opinion, that the recent weakness will last. A weaker dollar would be necessary to support a recovery in global growth outside of the US, and the continuation of a strong risk appetite would be a prerequisite for this depreciation to persist.

The early results in the Democratic candidacy race have been upset by the entry of Michael Bloomberg, who immediately polled in second place behind Bernie Sanders. We continue to believe that the Democratic choice of presidential candidate could have a material effect on investors, due to the strong socialist ideals of some candidates that will frighten markets.

The final risk not being priced in by financial markets concerns the inflation that could result from the squeeze in corporate margins further sustained by the supply-side disruption due to shutdown in China. US Housing Starts and PPI in January both surprised on the upside, and while the FOMC meeting agreed that current policy was appropriate, minutes revealed an active discussion around inflation and financial stability concerns in light of elevated equity valuations and corporate debt.

In the UK, Consumer Price Index inflation rose above expectation in January, at +1.8% vs.+1.3% in December. This was seen to justify the BOE’s decision to leave rates unchanged, although many economists expect inflation to move back down as early as February on the back of lower utility prices. The next potential inflection point in the UK is the March budget, where investors will be looking for commitments to fiscal spending designed to boost productivity. We agree that UK equities are relatively cheap among developed markets, but also recognize that there remains uncertainty as to the final shape of the UK-EU trade deal that may continue to hold back capital expenditure.

Turning to Europe, the euro is the worst performing G10 currency vs. the dollar and fell below 1.08 this month for the first time since April 2017[iv].

 

The second estimate for eurozone Q419 GDP remained unchanged at +0.1% quarter-on-quarter.  There is a growing realisation that growth in the eurozone is weakening again on the back of waning external trade and softening domestic demand, so that the expected pick up in domestic growth over 2020 is unlikely to materialise in the medium term.

In terms of asset allocation, we retain our view that there remains a heightened risk of equity drawdown and we believe that investors will need to become more vigilant around Easter, particularly if the coronavirus outbreak starts to have a material effect on global economic activity in the medium term. The expected support from emerging market economic growth, particularly in Asia, will be tested significantly by the spread of the virus. Greater risk aversion by investors could cause capital flight, leading to pressure on low interest rates.

 

[i] Absolute Strategy Research – Investment Committee Briefing 7^th February 2020.

[ii] Absolute Strategy Research – Profits downturn to persist 18^th February 2020

[iii] Julius Baer – Asset Allocation Perspectives 5^th February 2020

[iv] Capital Economics – Global Markets Update 19^th February 2020

 

By Jolette Persson, Hottinger Capital Partners

Q419 Chinese GDP growth of +6% year-on-year was in line with expectations. Industrial output at 6.9% and retail sales at 8% both surprised on the upside as the US and China came closer to their ‘phase one’ trade deal. Although it is encouraging to see that demand for spending and consumption has somewhat picked up alongside a steadily growing CPI – currently at 105.4 (though some of this is directly attributed to pork prices rising as a result of the African swine fever)[i] – property and infrastructure investments continue to slow. The fact that these are both key drivers of growth challenges the perception that China’s deceleration is coming to an end. China has historically built its economic growth on low-cost manufacturing, machinery and equipment and built its cities around factories to attract labour. As a result, close to a quarter of China’s economy is in real estate [ii].

India, another key driver of Asian growth, is expanding at its slowest pace for the last six years, down from close to 7% to 5% during 2019, followed by what has been a period of the weakest industrial production output in the last 8 years, high unemployment rates and slowing consumption. A decline in manufacturing might suggest that India’s economic issues are deeper rooted than initially thought, particularly as recent tax and interest rate cuts do not seem to have had a material effect on the economy. More concerningly, economists predict that India must grow in excess of 10% per annum to support the 12 million young workers entering the labour market every year [iii].

So what?

China being the world’s largest exporter by value (~$2.5trn) means that the magnitude of the effect of China’s growth on global growth is enormous. To put that into perspective, a 1% drop in China’s GDP shaves off 0.2% of global growth. This should not come as a surprise considering that China’s GDP represents approximately 19.24% of world GDP [iv]. In Europe, there is a clear relationship between the Chinese purchasing managers index and exports. Germany, with China as its largest trading partner, is likely to take the biggest hit from slowing Chinese growth of the European countries. For decades, China has provided a steady stream of income and contributed to growth in sectors such as automobile, machinery and engineering tools. German carmakers such as Volkswagen, Daimler and BMW all generate at least a third of their revenue from China, which has slowed significantly as a direct result of trade war tensions and their effect on Chinese demand for consumption, particularity on big-ticket items [v].

In the rest of the world, China’s largest trading partners – the US, Hong Kong, Japan and South Korea – have all suffered as a result of its slowing growth. Hong Kong’s economy contracted by 1.2% during 2019, pushing it into its first annual recession since the financial crisis in 2009, driven by trade conflicts and anti-government protests. Mainland Chinese travellers have since stopped going to Hong Kong (where they used to account for 70% of tourists), causing hotels, restaurants and the retail sector to plunge. Hong Kong’s exports, which mostly come from re-exported goods from China, have also reached an all-time low. Similarly, Japan’s manufacturing and exports to China have declined and the consumption tax hike in October 19 has further dampened demand and put off Chinese tourists, who are usually a major source of retail spend on luxury goods (~$16.4bn/year).

In India, IMF economists commented at the beginning of the year that India was the primary party responsible for the downgrade in forecasted global growth in 2020. Although we do not necessarily agree that India alone, more so than China, is a determining factor in global growth considering that it is a merely domestically-driven economy, India remains the fastest growing trillion-dollar and fifth largest economy in the world. As such, its output is not to be dismissed. The trade fallout between China and the US has hurt, but the decline in domestic consumption is the bigger problem. This has led to poor business sentiment, most evident in sectors such as automotive and manufacturing, as companies are refraining from capital expenditure.

Who stands to benefit?

Factors leading to today’s picture allows other countries to fill the gap and represent opportunities for some investors. We have already observed a change in dynamics whereby companies that normally extend their supply chains to China are now considering other countries such as Indonesia and Vietnam. Vietnam has already seen a huge increase in production and exports of smartphones and consumer electronics over the last 18 months. However, debates over local Vietnamese expertise in comparison to that of China still represent a hurdle despite the appeal of lower labour costs. Other countries, such as India and Indonesia, could eventually get to the point where they are regarded as exporters, provided that they continue to invest in infrastructure and policy reforms. Other direct beneficiaries of the US-China conflict include Latin American exports. Mexico, in particular, has been an unexpected winner as it has built out its manufacturing capability. In contrast to many countries in the Southeast Asia region, Mexico’s free trade agreements offer guaranteed access to more than 50 countries and it benefits from its geographical location being in close proximity to the US. Taiwan is the exception to the rest of Southeast Asia, whose additional exports to the US rose a whole 12.46% over the year totalling $85.48bn in 2019. This is reflective of its mature local tech industry that in turn has allowed its factories to ramp up capability and speed, with companies such as Taiwan Semiconductor Manufacturing Co. taking world-leading positions in their application. Taiwan also benefits from its geographical positioning with close trade links to mainland China [vi].

Bearing this in mind, 70% of surveyed European companies said that their supply chains had been disrupted to some extent and that holding off further action until real clarity is provided on trade is no longer considered a viable option. As such, we are forecasting additional haste for those companies looking to relocate production as well as more emphasis on supply chain diversification to avoid large and concentrated negative impacts in the future. We will continue to monitor the situation closely [vii].

[i] https://tradingeconomics.com/china/consumer-price-index-cpi

[ii] https://tradingeconomics.com/china

[iii] http://www.oecd.org/economy/india-economic-snapshot/

[iv] https://www.statista.com/statistics/270439/chinas-share-of-global-gross-domestic-product-gdp/

[v] https://think.ing.com/articles/germany-what-role-does-chinas-automotive-market-play-in-the-current-economic-slowdown/

[vi] https://www.ustradenumbers.com/country/taiwan/

[vii] https://www.china-briefing.com/news/eu-businesses-china-look-mitigate-trade-war-impact-eucham-2019-survey/

By Tom Wickers, Hottinger Investment Management 

The Alternative Investment Market (AIM) is a sub-market on the London Stock Exchange (LSE) which was introduced in 1995. The shares are unquoted (not listed on a recognised exchange) and provide a channel for companies to list and raise capital under lower regulatory requirements than in other developed equity markets. As such, AIM is largely used by smaller companies that do not meet the capital requirements of the main market or those that would find stricter compliance too costly, making it a hub for businesses with growth prospects rather than stable cash cows. The AIM market has grown substantially since its inception and is touted as being the world’s leading growth market[1]. By year end 2019, there were 851 companies listed on AIM with a total value of £103.9bn, in contrast to 121 companies listed at the end of 1995 with a value of just £2.4bn[2]. The companies listed on AIM are notably diverse, with the value in the AIM index relatively equally spread across the majority of sectors [Figure 1]. Investors can therefore allocate AIM portfolios according to forecast market trends as well as by individual stock-picking.

In 2013, AIM portfolios became more accessible to the general public as a law was passed making them permissible under an ISA wrapper. This allowed investors to mitigate capital gains and income tax via the ISA, as well as inheritance tax through the Business Property Relief (BPR) benefit of AIM investments (provided that certain criteria set by HMRC are met). The regulatory changes coincided with fundamental shifts in the characteristics of AIM stocks, leading to renewed interest from institutional investors in recent years.

Due to its venture capital slant, the AIM market holds higher intrinsic risk than more traditional indices such as the FTSE 100 Index. The companies have a lot of room for growth, but quick bankruptcies can also occur on the back of scandals or difficult market conditions. Financial news is littered with success and disaster stories; a prime example being Bidstack’s performance in 2019, climbing 526% in the first half of the year only to then lose 75% of its value in the second[3]. However, in aggregation, particularly in more recent years when the AIM market has become more established, AIM stocks have outperformed FTSE 100 stocks in returns with similar volatility levels[4] [Figure 2]. This is to be expected to compensate investors for the greater downside and liquidity risks involved. Drops in value are pronounced in the AIM market (as shown in Figure 2 at the end of 2018), the worst occurring following the financial crisis, where 65% losses were recorded[5]. Between 2015-20, the AIM All Share Index performed poorly, only marginally beating the FTSE 100 Index and underperforming the AIM 100 Index. In contrast, growth in the AIM 100 index was strong, outpacing the FTSE 100 by 31% over the time period shown. Should this trend continue, the opportunity would mostly lie in the largest AIM stocks, rather than the market as a whole.

Often nicknamed the ‘Wild West’ of markets, investors initially viewed the AIM market as a playing field for short-term, gung-ho punters because it had sparse research coverage and was prone to financial scandals and collapses[6]. Further, institutional investors did not need to get involved in the AIM market in order to access these successful companies as they were expected to move to a larger exchange once they had accumulated sufficient capital. Recently, however, larger companies have shown continued interest in staying on the AIM index, favouring the manoeuvrability that its softer regulation enables. Boohoo, currently the largest stock on AIM, has made no effort to move to the main market even though it is now large enough to list on the FTSE 100[7]. The result is that the AIM market has become more skewed towards relatively larger and more stable companies [Figure 3], providing a more investable environment for institutions.

The AIM market has materially shifted in the past ten years, still offering access to nascent companies but also to a plethora of established businesses that have thus far brought substantial returns at tolerable volatility levels. The shift from gamble to investment proposition means that institutional and individual investors alike should continue to watch this space. However, historical slumps provide ample warning of the palpable downside risks involved when investing both in individual companies and the index as a whole. Investors should take careful stock of their capacity to absorb losses before acquiring any significant holding in AIM shares.

[1] https://masterinvestor.co.uk/economics/aim-still-worlds-leading-growth-market/

https://www.londonstockexchange.com/companies-and-advisors/aim/for-companies/companies.htm

[2] https://www.londonstockexchange.com/statistics/markets/aim/aim.htm

[3] https://www.ii.co.uk/analysis-commentary/best-aim-stocks-2019-whos-1700-so-far-ii510030

[4] FTSE 100 weekly volatility was 1.79% in the time series, while AIM 100 volatility was 1.72%

[5] In reference to the AIM 100 Total Return Index (Gross Dividend) on Bloomberg from peak to trough.

[6] https://www.theguardian.com/business/2011/jun/24/langbar-international-fraud-history

[7] https://www.proactiveinvestors.co.uk/companies/news/278183/asos-seems-happy-to-be-aim-s-standard-bearer-28183.html

By Tim Sharp, Hottinger Investment Management 

Global monetary conditions remain tight and the risks for financial markets are that we may indeed be in late cycle, which could mean a global recession is likely within 12 months. This remains our base scenario and will be the reason we maintain our cautious stance in the near term, with the next likely inflection point around the beginning of the 2^nd quarter. This will coincide with 1^st quarter reporting, the selection of the Democratic candidate for the US presidency and also takes into account the fact that equity markets historically tend to try to predict economic outcomes 9 months ahead based on current economic forecasts.

Stock markets started the year strongly, buoyed by positive sentiment following agreement of a Phase 1 US-China trade deal and the strong majority of the Conservative party in the UK general election. US stock markets continue to lead the way, with technology stocks once more at the forefront of market movements. The S&P 500 is flat on the year while the tech-heavy NASDAQ was up 1.5% on the month despite anxiety at the outbreak and spread of the coronavirus in China, Asia and more widely, which has checked performance in other stock markets. European indices are down on average 2.5%, Japan 2.9% and the UK 3.0%.  The strength in UK equities seen towards the end of 2019 had largely played out by the start of the year, when the focus returned to the relatively short time period available for a new trade deal between the UK and Europe to be agreed. Our most recent investment strategy meeting took place on the last day of the UK’s membership of the EU, with withdrawal taking place at 11pm on January 31^st. This leaves the parties just 10 months in which to agree a deal within the existing timetable.

Government bonds have rallied since the outbreak of the coronavirus, which threatens to reduce Q1 GDP in China to 3.5% year-on-year from the 5.5% year-on-year predicted[i] with obvious knock-on effects to its largest trading partners including Asia Pacific, Japan and Europe. 10-year US Treasury yields have fallen from 1.92% to 1.51% and Gilt yields from 0.82% to 0.51%. The safe haven qualities of the US Dollar have also seen it strengthen 1.1%, once more painting a rather different scenario to that forecasted by many investment banks coming into 2020, albeit in the light of an unexpected epidemic. A strong dollar tends to reflect tight global monetary conditions and high funding costs will discourage foreign banks from lending dollars, meaning this position may persist.

The coronavirus is predicted to have a significant effect on Chinese Q1 growth, particularly due to the fact that it came to light just before the Lunar New Year celebrations. This will also affect the prospects of the Asia region as a whole, which many had predicted would be the catalyst for maintaining positive growth globally. However, this may only suppress spending in the short-term, with the possibility of a spike in demand once the worst of the outbreak has been overcome, rather than causing longer-term damage to global growth prospects, but which of these scenarios will materialise is currently an unknown. The reaction of financial markets indicates to us the vulnerability investors feel when faced with the potential of a worsening slowdown, leaving the risks firmly tilted to the downside.

The slowdown in corporate earnings over the last year has led to non-residential fixed investment falling in the US. Many forecasters predict that the 4^th quarter of 2019 will be a low point in earnings and economic momentum will turn positive this quarter. However, if earnings continue to fall then the capital expenditure recession will persist, putting further pressure on the benign economic scenario being painted. This is why we see 1^st quarter earnings as coming at an important time for markets.

European Q4 GDP came in weaker than expected, not just in Germany and Italy but also in France, which had been more robust in the past despite strikes and protests. The coronavirus is likely to weigh on January’s sentiment – surveys showed a small improvement in Eurozone activity, meaning that the expected economic recovery there will be slower than forecast and any sudden rebound is unlikely.

In the UK, November GDP was weaker than expected at -0.3% month-on-month, with both the services sector and industrial production faring poorly, resulting in many revising Q4 forecasts downwards. Furthermore, December inflation figures also came in below consensus and although January PMIs showed a bounce since the election, levels are still at or below long-term averages. The Bank of England’s Monetary Policy Committee will come under further pressure to cut rates over the coming months in order to support the economy.

At the FOMC meeting, the Fed left US rates unchanged and the statement following the meeting was much as before, suggesting that monetary policy remains appropriate despite the emergence of some new downside risks. Chair Powell did describe the coronavirus outbreak as a serious issue but it appears not to be serious enough to affect policy at this time. This reinforces our view that central bank reaction to a worsening economic scenario will be slow and too late to prevent recession.

In terms of asset allocation, we retain our view that a global economy in late cycle bears heightened risk of equity drawdown and we believe that investors will need to become more vigilant around Easter, particularly if the coronavirus outbreak starts to have a material effect on global economic activity in the medium term. The expected support from emerging market economic growth – particularly in Asia – will be significantly tested by the spread of the virus. Greater risk aversion by investors could cause capital flight, leading to pressure on low interest rates.

The remaining “known unknown” for investors is the US presidential race and reactions from the Trump administration to potential changes in economic performance that may affect chances of re-election. Furthermore, the Democratic choice of presidential candidate could have a material effect on investors as the current leading candidates have more socialist ideals that may frighten markets.

[i] Assessing the impact of coronavirus on the UK – Capital Economics 3 February 2020

 

By Jolette Persson, Hottinger Capital Partners

Going into 2020, industry leading dealmakers seem to disagree on the Mergers & Acquisitions outlook for this new year.

Some active participants paint a rosy picture, despite global geopolitical and trade-related uncertainty ahead. A common theme amongst practitioners is the belief that M&A transactions continue to be the most efficient way for companies to transform, particularly with regards to ongoing tech disruptions. Given the accelerating pace of technological change, there is a clear trend towards acquiring ready-made, tech-enabled solutions developed elsewhere rather than attempting to develop these internally, as falling behind the curve is a real threat and a rising one at that. Additionally, shareholder activism continues to prevail in M&A transactions as demand for breakups and corporate clarity remains at an all-time high[i].

More bearish dealmakers make a case for a repeat of last year’s modest increase in M&A activity, primarily driven by a balance between a dovish growth picture and the economic uncertainty of a possible recession. Global cross-border transaction volume in 2019 was down (-13% [ii]) compared to 2018, likely reflective of continued protectionist policymaking taking stronger precedence in dominant markets, particularly in the U.S and China. In Europe, factors impacting deal-making during the year included Brexit, a global slowdown in trade and concerningly low PMI readings in Germany. On top of these factors, several European governments strengthened their regulatory regime in 2019 (as did the US, after multiple waves of intense industry consolidation) which further pushed down appetite not only for M&A transactions but also for wider European equity markets, as European companies either cancelled or put their IPO plans on hold.

As UK-based investors, the question remains whether the Eurozone will regain its competitiveness as a turnaround market relative to that of the US and Asia, particularly as the UK has historically served as a gateway in European expansion strategies. Certainly, from a valuation point of view, UK-based assets continue to trade on wide discounts to global equities, both public and private. With Boris Johnson winning the general election and “sufficient” progress being made in Brexit talks, it is expected that M&A activity will pick up in the region in 2020. This is further supported by easy financing conditions. Early indications of a rebound became evident during the month of December 2019, with a clear spike in acquisitions of UK assets, predominantly in IT, where total deal value was £625m [iii].

Elsewhere in the UK market, 2019 saw the highest deal volume since 2007 in take-private transactions by private equity buyers; a focus that is likely to continue in 2020. Given the record high level of dry powder in private markets (+£1.45tn of private equity capital alone [iv]), the wider industry consensus envisions private equity investors being very active in both public and private market opportunities in 2020. Private equity fundraising in Europe, although not as strong as in North America, remained robust throughout 2019, supported by a continued benign interest rate environment.

Going forward, cross-border dealmaking in the UK and wider Europe is expected to be driven by flows between Europe and Asia rather than the usual Europe-North American route. European companies and Asian investors rightfully remain nervous around further regulatory challenges pending in the US. The expanded CFIUS jurisdiction* due to be implemented in 2020 represents a significant risk for acquisition targets involved in advanced technologies, infrastructure or consumer data. Simultaneously, European companies deprived of growth cannot ignore the far more favourable growth prospects and demographics prevailing in Asia going into 2020.

*“CFIUS is an interagency committee authorized to review certain transactions involving foreign investment in the United States (“covered transactions”), in order to determine the effect of such transactions on the national security of the United States.”

[i] JPMorgan, 2020 Global M&A Outlook Annual Report

[ii] Dealogic data as of 12/31/19

[iii] GlobalData’s deals database

[iv] CNBC, Private equity’s record $1.5 trillion cash pile comes with a new set of challenges 03/01/20

By Laura Catterson, Hottinger Investment Management 

A term of economic plight, ‘Japanification’ is characterised by a sustained period of anaemic growth, very low interest rates, negative inflation and high government indebtedness. This is a cycle Japan has found itself in for almost three decades, with its aging population making it difficult to escape[i]. Stymied by a lack of policy flexibility, Europe continues to experience similar economic conditions, prompting many market watchers to consider whether it will succumb to a similar fate or whether notable differences between the two economies will favour the Eurozone in the future.

Following WWII, reconstruction narrowed Japan’s focus onto industrialisation and by 1978 it became the second largest economy in the world. However, weak yen policy addressed at the 1985 Plaza Accord led to significant appreciation ‘bringing exports to a standstill and abruptly halting growth’[i]. A horde of stimuli followed. Financial deregulation and loose monetary policy led to a fall in bond yields and significant easing of credit conditions. Outstanding loans rose to more than 210% of nominal GDP in 1990, up from around 140% at the beginning of the 1980s[ii]. Additionally, the acquisition of financial market securities and real estate prompted a surge in prices and by the beginning of the 1990s the market capitalisation of listed companies in Japan had increased fourfold, reaching approximately 140% of GDP[ii]. This explosive growth, coupled with speculative hysteria, caused the economy to significantly overheat. In response, the Bank of Japan raised rates in the early 90s (and held them at this rate until the mid-90s), causing a spectacular asset bubble burst. An immediate – yet short lived – spike in inflation caused by the crash preceded deflation due to the withdrawal of credit supply, which led to further depressed economic conditions and an unprecedented amount of quantitative easing.

The Eurozone currently finds itself in a similarly feeble economic environment which, at first glance, bears a striking resemblance to Japan’s ‘lost decade’ of the 90s. However, there are notable distinctions to be made so as to avoid bold comparisons.

Over the last 10 years, GDP growth year-on-year for both regions is close to parallel, remaining in a narrow range between 2% and negative 1%, however, significant national differences are masked by aggregate figures with southern Europe, namely Italy and Spain, being hit harder by the 2012 debt crisis and two consecutive recessions than the rest of the bloc. Europe is still running ahead of Japan in terms of growth and there is hope that this will continue with additional stimulus from the ECB.

 

 

Inflation is another area where similarities, yet also notable distinctions, can be drawn. Figure 2 clearly shows  where policy rates have come into force(rates have been negative for both since the 2008 recession). Both regions have been   unable to generate any effective inflation, suggesting that their economies are still running very slowly. Nevertheless, whilst the Eurozone is yet to reach its target level of 2% inflation, it has avoided deflationary years. By contrast, negative inflation has occurred 12 times in Japan since 1991, with the first deflationary month occurring after just three years[iii].

 

The Eurozone has managed to get its banks lending again following the financial crisis faster than Japan did after its credit boom collapse. If central bankers can continue to deliver accommodative monetary policy, ‘money supply should continue to grow above the rate of inflation and lending should remain positive too’[iv]. Coupled with the appreciation of real assets, Figure 3 suggests the Eurozone’s current situation stands in stark contrast to Japan’s enduring deflationary bust of the 1990s [iii].

Another negative trend in Japan and a significant contributor to long-term stagnation has been the decline of its working age population. In a bid to tackle this issue, Japan has drawn a lot of women and young people into the labour force, pushing employment to 60.9%[v], however that rate is unsustainable if the size of the population does not increase. Adding to this challenge is Japan’s inadequate pension system, which results in an over-reliance on younger generations. The public pension, which serves as the main source of income in retirement, is limited and thus burdens the youth with taking on additional risk in order to have any hope of supporting their latter years[vi].  Although a concern for the Eurozone, breathing room comes in the form of its structural advantages over Japan, which it will need to capitalise on in order to accumulate capital. These advantages include a relatively liberal approach to immigration, the global exposure and reach of European companies and the expansion of industries with the potential for strong growth. One such industry is  renewables, where Europe currently leads the world. Additionally, Europe will have to make significant advancements in robotics and automation if it is to maintain its GDP per capita at the current high levels whilst the population continues to age.

Japan’s inability to recover completely from the asset bubble burst of the 90s can be attributed to a slow and timid response by the central bank, coupled with significant mismanagement. With a government bailout only forthcoming at the end of the 90s, zombie firms, propped up by banks to prevent mass unemployment, staggered on, draining growth and being ‘unable to service their debts’[i]. For the Eurozone to avoid a similar fate, boosting potential growth and maintaining resilience against significant economic headwinds is key. It is still debatable whether quantitative easing can provide meaningful short-term growth without supressing growth metrics in the long-term[vii]. The Eurozone may need to look to fiscal policy to fully escape its current lull. For this to manifest, swift – albeit likely unpopular – structural and stimulus decisions are vital.

[i] https://www.worldfinance.com/wealth-management/europes-growing-risk-of-japanification

[ii] https://economic-research.bnpparibas.com/Views/DisplayPublication.aspx?type=document&IdPdf=38519

[iii] According to Bloomberg Japan CPI Year on Year at -.3% July 1994

[iv] https://www.rathbones.com/sites/default/files/imce/22_rathbones_investment_insights_q4_2019_v8.pdf

[v] https://tradingeconomics.com/japan/employment-rate

[vi] https://www.japantimes.co.jp/news/2019/06/04/business/financial-markets/japans-pension-system-inadequate-aging-society-council-warns/#.Xib3Fsj7S70

[vii] https://www.ft.com/content/031b49ec-c415-11e4-9019-00144feab7de

By Tom Wickers, Hottinger Investment Management 

In October, the Financial Times published an article calling attention to the drab performance of big technology stocks[1]. FAANG (Facebook, Apple, Amazon, Netflix and Google/Alphabet) returns waned in the face of wavering economic confidence over the summer as investors cycled more defensive stocks into their portfolios. Since then, Big Tech returns have rocketed. An analysis of this year’s cumulative returns of FAAMG – which substitutes Microsoft for Netflix and represents the five largest technology companies in the world – demonstrates just how strong their performance has been.

To provide some idea of the size of the FAAMG stocks, they represent the five largest companies in the world[2] aside from the newcomer Aramco. As at the end of 2019, their combined equity values constituted 23.47% of estimated US GDP[3] which is also 5.70% of estimated global GDP[4]. Turn the clock back ten years and only Microsoft featured as a top five global company[5]. On New Year’s Eve, Apple’s market capitalisation reached heights no company has achieved before, breaking the $1.3T mark. Looking forward to 2020 and the decade ahead, can we realistically expect these mammoths to continue to grow or could we see them stall or even become extinct?

While the tech industry is notably cyclical, the outperformance of big tech stocks can largely be attributed to the surprising promise they have shown at being able to adapt and innovate this year. Apple’s 2019 iPhone sales dipped in line with expectations; few users took the plunge to upgrade to the new model. However, this disappointment was outweighed by the potential of their wearable products that grew by 50% in the year to June[6]. Apple’s ability to successfully innovate away from its legacy product led analysts to factor substantial sales growth for the next few years into their valuation. Meanwhile Microsoft’s cloud services enticed investors, demonstrating year-on-year sales growth of 59% in its latest quarter[7], mirroring Apple in recent innovation progress. Finally, Facebook has so far managed to negotiate regulatory difficulties, shrugging off its dampened share price last year following the Cambridge Analytica scandal and gaining another 254 million users in the process[8].

At the turn of this year, evaluating FAAMG using a basic value metric, Market Value/Free Cash Flow (FCF)[9], highlights how expensive these stocks have become. A high figure suggests that in relation to other companies, the ratio of expected future FCFs to current FCFs is sizable and/or that these cash flows are seen as less risky.

As technology is a cyclical and risky sector, a significant proportion of the high prices of these stocks can be accredited to cash flow growth prospects. When considering that the majority of these stocks already generate significant cash flow in comparison to their sales, markets are already pricing in weighty sales growth for FAAMG stocks in the 2020s.

Based on these numbers, it is difficult to imagine FAAMG prices climbing much higher this year. Positive investment research tends to point to the opportunities in the services sector[10], such as Apple’s foray into TV production and Microsoft’s success in cloud provision. Services are seen as a more stable sector than technology, less susceptible to revenue fluctuations due to subscriptions and contracts. Lower risk in revenues would lead to further bolstered valuations. However, it is worth noting that these services are highly contested areas at the moment. Disney, Amazon, HBO and Netflix are all battling for viewer subscriptions and there is a war ongoing between Amazon’s AWS and Microsoft’s Azure cloud services. Progress in different services sectors for these giants is not a given and a win for one can often mean a loss for another. The current stock prices therefore continue to look hopeful and on the steep side.

For an outlook on the decade, it is worth noting how FAAMG companies appear to be bucking technology trends. The average technology company quickly blossoms, matures and withers as innovation surpasses them and their products become redundant. However, big tech companies are generally succeeding in branching out and diversifying their revenue streams, slowly transforming from technology companies into quasi-conglomerates. Their size allows them to stay at the forefront of demand, through massive databanks (which are proving to be barriers to entry for newcomers[11]) and big buying power for acquisitions. Damaging regulation, which has been a major concern for investors, has so far been avoided as a result of the global reach of FAAMG companies as well as their spending power; demonstrated by Facebook and its self-regulating investments following the Cambridge Analytica scandal. Further, diversification will lessen the damage of any potential future regulation. These forays into new technology and new sectors should keep big tech alive but will ultimately lead to more melees and increased competition as giants venture into similar products. Over the coming years, FAAMG growth is unlikely to reach levels anywhere near that experienced in the 2010s – any large big tech growth would most likely come from Asia where technology is starting to diverge due to nationalism. Nonetheless, these companies are here to stay and offer substantial exposures to the American and global economies that still hold the prospect of competitive returns.

[1] https://www.ft.com/content/5a6a95e6-e67e-11e9-b112-9624ec9edc59

[2] In terms of their market capitalisation – data from Bloomberg as of 10/01/2020

[3] https://www.jpmorgan.com/global/research/global-market-outlook-2020

https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=US

[4] https://www.statista.com/statistics/268750/global-gross-domestic-product-gdp/

[5] http://media.ft.com/cms/419e021c-fecd-11de-91d7-00144feab49a.pdf

[6] https://www.cnbc.com/2019/10/31/apple-wearables-business-growing-at-a-50percent-and-impressing-wall-street.html

[7] https://www.barrons.com/articles/microsoft-stock-soared-in-2019-51578002778

[8] https://www.statista.com/statistics/264810/number-of-monthly-active-facebook-users-worldwide/

[9] Market Value/Free Cash Flow (FCF) is similar to a P/E ratio in its use but is more relevant to the factors that determine valuation and is less prone to manipulation. However, it can also be noted that current PE ratios make FAAMG stocks look expensive.

[10] J.P. Morgan, ‘Apple: Are Shares Expensive? Thoughts on What’s Priced in Already, and What Remains on the Table’, 06/01/2020

Deutsche Bank Research, ‘Microsoft: Pre-Quiet IR Catch-Up’, 16/12/2019

[11] https://www.economist.com/leaders/2017/05/06/the-worlds-most-valuable-resource-is-no-longer-oil-but-data