Brexit fixation distracts from these cyclical tell-tale signs

With more than one banana skin to catch investors out, companies analyst Edmond Jackson explains why secure dividend-yielding stocks are not a bad place to be.

Cheesed off with Brexit?  Well it’s now the prime issue for UK risk assets, especially financial stocks de-rated to fat dividend yields amid the uncertainties.  Whether or not there’s a major buying opportunity means keeping attuned.

My working assumption has been that Theresa May's compromise with the EU will be voted down on a first parliamentary vote – a chance for MP's to let off steam – then get passed a second time, on the basis "Teflon Theresa" puts it to another vote once MP's have reflected over the Christmas recess.  Abstentions would then kick in and tip the balance in favour.

But I concede that the withdrawal bill could be so overwhelmingly defeated, alternative proposals then glean support, based on deferring the UK's withdrawal date.  Mrs May now says she will prepare for no deal if her plan is rejected, though at exactly what stage remains to be seen.

Not even constitutional experts can offer a reliable view whether Mrs May would have to resign, there be a second referendum or general election – so the uncertainties look set to drag on, which is potentially very useful for UK equities buying. 

In a soft Brexit scenario, and assuming financial services' can passport into the EU (or on other satisfactory alternative terms), then bank and insurance company shares ought to rate ‘buy’ and could rise on speculation anyway.

If the Bank of England governor's worse-case scenario results from "no-deal", cashed-out investors can look forward to much wider buying opportunities, albeit pain for investors riding out any downturn if dividends get compromised.  No one has a crystal ball though, and bold claims usually say more about the forecaster than reality.

Weakening US fundamentals, to weigh on stocks?

Meanwhile, the dilemma of overvalued US stocks versus a large and growing US budget deficit, and lower domestic growth forecasts, hasn't gone away.

New home sales fell 8.9% in October or 12% year-on-year, the steepest since last December, against consensus for 4.0% growth; and housebuilders' confidence fell the most in four years this November, this industry being an important contributor to GDP.

Also, recreational vehicle, or RV, sales fell in October by 11%, or 1% year-on-year.  RV's can be a useful leading indicator: dropping in 1999 even though the economy did not slide until 2001; then a 9.5% fall from 2006 to 2007 while GDP advanced 4.5%; then they slowed to 1.7% and fell by 2.0% from 2008 to 2009. 

RV's tend to mimic the US Conference Board's leading economic indicator index which is based on wide measures; big ticket items being more easily deferred if confidence falls.  Obviously, tariffs have increased the price of steel and aluminium required to build RV's, but it's unclear whether this is having – or is yet to have – much effect.

I'm alert not to fall into the trap of confirmation bias regarding my caution towards the US, given inflated stock values and a government that's cut taxes potentially late in the economic cycle.  But should there be such drops in home and RV sales if "supply side" economists favouring tax cuts – and Trump entertaining 4% annual growth – are correct?  

Moreover, US farming bankruptcies have jumped in context of low global demand for corn, soya, milk and beef, although Trump's trade war has meant China slapped billions of dollars of tariffs on US agriculture exports, and Canada added duties to agricultural imports in response to US import tariffs on steel and aluminium.

US tariffs on Chinese goods could rise from 10% to 25% in January unless there's a new agreement in the weeks ahead.  Trump has said he may not impose additional tariffs, though there's not much shift in tone on either side, with issues such as IP theft apparently without solution (the Chinese reject it happens at all).

Thus, I am wary about how such factors could conflate adversely, at the time the Federal Reserve is raising interest rates to try and "normalise" before the next recession.  A worse-case scenario is US tax cuts resulting chiefly in price-rises (given a tight labour market currently) hence stagflation, which would really jolt equities.

US stock indices rebounded this last week amid hopes a G20 summit will result in positive trade developments.  Technology stocks jumped in the prospect these companies could be distinguished in a lower growth scenario.  But sentiment inevitably shifts, and it's early to assert any trend: the S&P 500 index is broadly flat for 2018, currently finding support after October's 9.6% decline, on a trailing 12-month price/earnings (PE) multiple of 21.9 relative to a long-term average of 15.7.

Further indicators, the cycle may be rolling over

Germany's economy contracted in the third quarter of 2018 for the first time in three years, and Japan also slowed in Q3.  Oil prices have slumped in November, with Brent crude down over 30% to $59 a barrel currently.  Given the extent of speculative trading in oil nowadays it can be hard deciphering whether such change reflects mainly market technicals – as leveraged positions get liquidated - or economic fundamentals, as if a demand drop portends recession.

Recalling early 2015 when oil prices plunged (with petrol down to 99p/litre), bears warned of a deflationary doomsday and yet the global economy rocked on.  For now, I’d note how oil’s current fall coincides with other indicators down.

An apparent burst in the cryptocurrency bubble is also interesting, as if various "assets" are deflating; crypto's dilemma being no proof of underlying intrinsic value, only what people are prepared to pay. 

• Is this the end of bitcoin?

To me, crypto is fake money because it's no reasonably reliable store of value, isn’t backed by anyone and exchange can be tricky, so doesn't meet the test of a genuine currency.

Financial authorities are partly culpable for its rise: the 2008 crisis coming after weak regulation and prompting a rebellion against fiat money; then years of central banks' monetary stimulus unleashed myriad asset bubbles – crypto being just one.

Embezzlement continues to emerge

It's hardly a rush, albeit intriguing relative to economic and technical market indicators, how "the bezzle" seems to be rising.  The term was made popular by 20th century economist John Kenneth Galbraith, to define "a magic interval when a confidence trickster knows he has the money he has appropriated but the victim does not yet understand that he has lost it."

Embezzlement exists at all stages of the business cycle but takes off in a boom when standards slip and people are more trusting than in a downturn.  AIM-listed Patisserie Holdings is the prime current example in the UK stockmarket, where the finance director has been arrested and bailed, and historic accounts need re-stating.

Yet such examples are patchy, the AIM market is going to involve some blow-ups and the aftermath of Carillion hasn't led to support services' implosions.  Patisserie leaves a sour taste but maybe only a hard Brexit will open further cans of worms.

A notable global example is Malaysia pursuing Goldman Sachs for over $600 million (£470 million) by way of fees earned and reputational damage, after the US investment bank raised $6.5 billion over 2012-2013 for state investment fund "1Malyasia Development Berhad".

A bribery and embezzlement scheme has resulted in about $2.7 billion plundered from 1MD, two former Goldman bankers have been indicted by the US Department of Justice, and an Abu Dhabi sovereign wealth fund has sued Goldman for allegedly bribing its officials during the 1MDB fraud.  It looks a classic scandal that appears after standards drop in a long boom, this one engineered by QE and ultra-low interest rates.  

Thus, and mindful not to slip into confirmation bias, it's interesting to link these examples with macro indicators implying the business cycle is rolling over.  Cash and secure dividend-yielding stocks are not a bad place to be.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.