Mechelany Advisors' WEEKLY MARKET REVIEW highlights the salient feature of the past week, details specific issues of the moment and reviews the Mechelany Advisors' MODLE PORTFOLIO
Beware of Breadth
With a strong reversal on Friday, many global indexes reached new all-time highs again. US technology stocks led the charge with Apple Inc. recording a new all-time high as well.
On Wall Street, all three major averages notched record closes on Friday, after a sell-off the day before prompted by fears of slowing growth and worries that new Covid-19 variants could stall the global economic recovery.
The Dow Jones rose 448 points on Friday, or 1.3%, to a record close of 34,870. The S&P 500 bounced by about 1.1%, hitting an all-time high close of 4,370. The technology-heavy Nasdaq Composite rose 1% to close at a record of 14,702.
For the week, the Dow Jones rose 0.68%; the S&P 500 gained 1.1 5 % and the Nasdaq 1.24 %. European Stocks were less buoyant while Asia was clearly negative with the Tokyo Olympics shut down to spectators and many cities around Asia resuming lockdowns.
However, the Friday bullish momentum in the US SP500, was mostly based on a handful of mega cap technology stocks, whereas in most other key sectors we saw no momentum at all.
Market breadth refers to how many stocks are participating in a given move in an index or on a stock exchange. The indexes may be rising butmore than half the stocks in the index are falling because a small number of stocks have such large gains that they drag the whole index higher. This is usually a bad sign for markets ahead.
Breadth has been poor for weeks now, but last week, even in the tech sector only Apple managed to make a new high.
The VIX index has not confirmed last week’s SP500 breakout.
Globally, most markets in Europe and Asia are either trading sideways or are in correction mode, and the same applies to most US key sectors. Together with technology at overbought extremes, this leaves our picture unchanged to see a significant pullback in global equities into later July and into August.
The global picture is more and more resembling the ones that prevailed just before the March 2020 crash and the 2018 correction, with a massive divergence between new record highs and weakening participation ( Breadth )
Even Apple Inc’s new all-time high is sending a warning signal. A Break down in the ONLY tech stock making new highs could spell trouble for the whole market.
Equity investors are shrugging off the fast spreading of the new variant of COVID-19, have stopped worrying about sustained inflation and are pricing the next batch of corporate earnings to perfection.
The US earnings season kicks off next week and several large US banks will report their results for Q2. Investors will also keep an eye on Fed Chair Powell semi-annual report to Congress. On the data front, consumer and producer inflation, retail sales and industrial production will provide an update on the economic recovery. Elsewhere, China GDP growth for Q2, UK CPI and jobless numbers and BoJ interest rate decision will also be in the spotlight.
All through the pandemic era, buying stocks when corporate America delivers its quarterly reporting card has been a reliable winning trade. But the streak may be coming to an end.
While second-quarter profits may look robust when banks start reporting on July 13, the forecast earnings increase of 64% for all firms in the S&P 500Index probably marks the top of this expansion cycle.
That’s adding to concerns that everything that has bolstered this 15-month bull market, from an economic boom to massive policy support, is poised to lose steam.
If history is any guide, equity bulls have reasons to worry. Peaks in profit growth have tended to foreshadow subpar performance in stocks, almost a century of data compiled by S&P Dow Jones Indices and Bloomberg show.
A potential economic slowdown, the spread of a highly contagious coronavirus variant and the specter of Federal Reserve scaling back monetary stimulus are prompting many fund managers to raise cash and many hedge fund managers to warn investors.
Signs of a weakening economy have rattled financial markets in recent weeks, contributing to a drop in 10-year Treasury yields. Meanwhile, economically sensitive shares like banks have lost some luster while steady growers such as technology are back in vogue.
After second-quarter results finish rolling out, income growth for S&P 500 firms is forecast to slow in each of the next three quarters as the boost from government stimulus winds down and the base effect from the pandemic recession fades.
By the start of next year, the pace of profit growth will dwindle to less than 5%, a fraction of what’s expected to be the fastest expansion in more than a decade for the quarter just ended, data compiled by Bloomberg show.
Similar post-peak periods haven’t boded well for stocks in the past. Since 1927, when earnings momentum started waning, two-thirds of the time the S&P 500 fell or performed worse than usual in the following quarter.
The latest example came after President Donald Trump’s tax cuts boosted corporate earnings in 2018. Growth topped out in the third quarter of that year, right before the S&P 500’s 14% drop over the next three months.
With stocks now trading near the highest price-earnings multiples since the dot-com era, there is little room for error.
And yet from President Joe Biden’s proposed tax hikes to pricing pressure from higher costs of labor and raw materials, the threat to corporate bottom line isn’t insignificant.
There is excessive complacency in the market currently, as too many people we talk to think a smooth transition from monetary policy support to that of earnings will play out. We are clearly less confident.
The convergence of profit-margin pressures, inflation fears, Fed tapering and taxation contributing to a drawdown that we expect to unfold in the coming weeks. There is no doubt that we expected the correction earlier and that we have been surprised by the strength of the market.
However, with our ultimate target of 4’400 to 4’500 already in sight, the top may be coming much earlier than initially expected.
Weekly Market Review 10th July 2021
Bond markets had a significant blowoff move with the US 10 years Government bond trading at 1.25 % at one point before closing at 1.36 %, marking a significant reversal. for now. The yield on the benchmark 10-year Treasury note rose 7 basis points to 1.36% on Friday, after falling to February lows of 1.25% earlier in the week, easing concerns over a slowdown in global growth even though Delta Covid-19 risks remain.
During the week, Fed’s meeting minutes showed policymakers’ standard of substantial further progress on the economic recovery was generally seen as not having yet been met, though progress was expected to continue.
Commodities has a mixed week with oil clearly peaking after having reached the highest level since 2018, Copper, Gold and Nickel still rising on the week, while soft commodities and Corn in particular collapsing.
The Fed noted that progress on vaccinations has led to a reopening of the economy and strong economic growth, supported by accommodative monetary and fiscal policy while shortages of material inputs and difficulties in hiring have held down activity in a number of industries, the Monetary Policy Report which will be the subject of hearings in Congress in July showed. The central bank reinforced it will be appropriate to maintain the current target range for the federal funds rate until labour market conditions have reached levels consistent with maximum employment and inflation has risen to 2% and is on track to moderately exceed that rate for some time. On the QE programme, the Fed expects purchases to continue at least at the current pace until substantial further progress has been made toward its maximum-employment and price-stability goals.
The US services sector grew less than unexpected in June, according to ISM survey. Also, the jobs report released last week was not strong enough to raise inflation and tightening concerns as wages increased slightly less than expected while the unemployment rate surprisingly edged up
In Europe, the European Central Bank policymakers discussed a cut in stimulus during the last monetary policy meeting in June but concluded that financing conditions were too fragile to allow a meaningful reduction in the pace of purchases without risking a disorderly rise in yields, meeting minutes showed. As a result, a slowing of the pace of purchases for the next quarter was seen as inappropriate. The ECB also noted that if the outlook for growth and inflation improves, asset purchases should be scaled back somewhat but also warned that even an increase in asset purchases could be justified if inflation falls short of expectations. The ECB left monetary policy unchanged during its June meeting, saying it expects net purchases under the PEPP over the coming quarter to continue to be conducted at a significantly higher pace than during the first months of the year. It also revised up GDP projections for 2021 and 2022 to 4.6% and 4.7%, respectively.
The British economy grew 3.6% in the 3 months to May of 2021, the strongest growth since November but slightly less than market forecasts of 3.9%. Strong retail sales, increased levels of attendance as schools reopened from March, and the reopening of food and beverage service activities drove the expansion. Considering May only, when indoor areas of hospitality venues reopened, the economy advanced 0.8%, nearly half of market forecasts of a 1.5% gain. Accommodation and food service activities grew by 37.1%; the production sector returned to growth (0.8%), mainly because of adverse weather conditions in May boosting output in electricity, gas and air supply. In contrast, manufacture of transport equipment fell by 16.5%, its largest fall since April 2020 as microchip shortages disrupted car production and construction fell for a second consecutive month by 0.8%. Still, the British economy remains 3.1% below the pre-coronavirus pandemic levels seen in February 2020
The Canadian economy created 231 thousand jobs in June of 2021, above market expectations of a 195 thousand rise and following a cumulative decline of 275,000 over the previous two months. Job gains were entirely in part-time work (+264,000) and concentrated among youth aged 15 to 24 (+164,000; +7.1%), primarily young women, marking the largest single-month increase for this age group since July 2020. Meanwhile, full-time work was little changed (-33 thousand). Employment rose markedly in June in several services-producing industries where a high proportion of jobs involve face-to-face interactions with the public, including accommodation and food services (+101,000), retail trade (+75,000), and “other” services (+24,000). Employment increased in Ontario, Quebec, British Columbia and Nova Scotia.
In China, The Chinese State Council said in July it wants financial institutions to reduce fees and make profits, and benefit enterprises and people. The authority hinted that the People’s Bank of China could boost lending to businesses, including by cutting the amount of money banks need to hold in reserve, or RRR. The move raised prospects about easing monetary policy in China and increased concerns over a slowdown in the second largest economy.
On Friday, The PBoC cut the reserve requirement ratio (RRR) for all banks by 50 bps on July 9th 2021, saying it is a routine operation as monetary policy returns to normal. The weighed average RRR for all financial institutions stands at 8.9% after the cut, although banks that are subject to an RRR of 5% will be exempted. The measure will free around CNY 1 trillion in long-term liquidity to help boost growth and repay maturing medium-term loan facility for financial institutions.
During the week, China took an aggressive stance against the ride-hailing giant Didi, after the company went ahead with its US IPO despite warnings from the Government that it was going to probe its activities and data collection practices.
Didi Global Inc.’s post-debut debacle highlighted Beijing’s regulatory supremacy. Its shares got punished after the Cyberspace Administration of China launched a review of its data practices just two days after the company’s New York public offering.
The crisis got worse for Didi, and quickly spread to other U.S.-listed Chinese stocks. Its ride-hailing app was banned from app stores in China, and its corporate structure was thrust in the spotlight. Investors had been betting that the company had avoided the fate that befell Ant Group Co. last year, when the fintech affiliate of Alibaba Group Holding Ltd. had its Hong Kong initial public offering canceled after choice words by founder Jack Ma against China’s banking system.
Yet Beijing has had a wary eye on overseas listing for a while. The variable interest entity structure, which allowed Chinese companies to skirt foreign ownership laws, was a loophole that had been left open but never formally approved. Now, under the guise of national security, mainland businesses that want to list on foreign bourses will be in for a rough ride.
For once, China and US China Hawks See Eye-to-Eye: After years of squabbling over everything from soybeans and viruses to technology and Taiwan, it now looks like Beijing and Washington may be on the same page about one thing: U.S.-listed Chinese companies.
Beijing doesn’t want companies with reams of data listing in the U.S., and skeptics in Washington (and Wall Street) are making it increasingly clear that opaque Chinese businesses aren’t welcome in its capital markets.
The U.S. has tried very hard to deter Chinese companies from going public there, even threatening delisting procedures. Yet they keep on raising fresh capital, simply because investors have the appetite, regardless of the risk.
But as the traded financial war intensifies, China has a growing incentive to keep its tech giants, and their cash, at home. Moreover, and as we highlighted in our recent posts about the strategic importance of Big Data to Sovereign nations, the Chinese clampdown on data collection, storage and usage is not over yet.
Foreign investors wanting the man a quick buck from Chinese tea IPOs may be ultimately paying the price. On the other hand, these companies are now becoming cheap with regards to their growth and earnings potential.
The sharp sell-off in Chinese Technology stocks and the Hong Kong-listed Chinese H-shares Index HSCEI is opening up a buying opportunity in our view.
Starting with the Index, the cheapest equity market in the investable universe closed the week below 10’000, a level that is fundamentally and technically attractive.
The HSCEi Index lost 20 % of its value since the February 2021 peak and last week alone saw the index lose almost 10 % of its value, making not extremely oversold.
What is really interesting is that it is now trading on the major support of the massive triangle in place since the 2008 financial crisis, a level that has always been a great buying opportunity for a rebound at least toward the upper boundary of the triangle.
Now coming to specific Chinese tech stocks , although the clamp down may not be over, we see opportunities at current levels for long term investors in the following stocks :
MODEL PORTFOLIO 10 Jul 2021 + 46.30 % YTD
Our Model Portfolio rose +1.67 % last week despite being heavily short equity markets and technology stocks. Our NAV is hovering juts under 450 and our IRR just under 22 % confirming its significant outperformance vis-a-vis the world equity indexes.
The main contributions to our positive performances last week came form the rise in Bond markets ( 50 % of our exposure ), the strong performance of China Zheng Tong, our largest individual equity position, and the collapse in Meme stocks, where, despite our relatively small exposure, we generated some nice profits.
For the rest, most of our Commodities and equity positions were negative contributors and our short US tech stocks worked against us.
During the week, we added positions in Genome sequencing stocks, Gold Miners and Silver while re-instating our short positions in Apple, Microsoft, Google and Amazon. We also shorted ETHEREUM again.
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