Stockwatch: Look forward to better value ahead

A flurry of uncertainty is hitting stocks just as the summer holiday period, when we typically see volatility pick up in thin trading, approaches.  

What extent of trade war is underway?  Will tariffs end up offsetting President Trump's tax cuts?  Is the US economy near some kind of peak, coinciding with weakness in China?  Did stockmarkets peak in the New Year?  

Oil price strength has boosted those shares giving equities respite from falls, although rising oil can end up checking global growth.  Thus, the balance of stories has tipped negatively, while the UK continues to obsess about Brexit.

"Buy the dips" coming under pressure

Despite the US market opening down on trade fears a number of times during June, data shows it recovering intra-day to close in the upper 85% of its range.  Chart-wise it remains in a bullish channel from 2015 lows, although is possibly over-bought, so trade may be a convenient excuse to sell off. Near-term sentiment is quite critical, with either a return to all-time highs or a correction to re-test support both possible.  

This last week of June did, however, begin with a progressive intra-day decline as technology stocks reacted to Trump administration talk of curbing foreign investment from China, indeed "all countries that are trying to steal our technology."  US stocks have previously enjoyed support from the technology sector, so in a sense it was least exposed to tariffs compared with industrial/agricultural-related stocks.  

The general fear is that China retaliates beyond mere tariffs, leading to higher corporate costs and restricted activity.  Coincidentally, the trend in economic data for Europe and China has softened versus New Year optimism for global expansion.

Is angst over trade genuinely rational? 

Markets are trying to fathom if tit-for-tat moves between the US and China/EU is a skirmish within respected trading rules or drifting into a genuine trade war.  The various sides say retaliation will be met with further retaliation, and meaningful talks have broken down, but not into unilateral actions with no regard to levels of tariff. "Trade war games" perhaps.  

As yet the cost is small in context - new trade taxes on $50 billion of Chinese imports potentially rising over $150 billion, relative to nearly $20 trillion US economic output.  The US economy is also geared to domestic consumption with exports constituting a modest 12% of GDP.  

The fear is where all this is leading. It's about whether trade conflicts could undermine other aspects of the US economy such as corporate investment, undermining a stockmarket still at elevated levels.  It also comes in a context of a flat-to-inverted yield curve on US bonds - where those short-dated start to return more that long-term yields - which tends to be seen as a fore-runner of recession.

The true impact of Brexit: anyone's guess!

Nowadays I attend fewer city presentations, preferring to focus on the evidence companies publish than get swayed by agendas.  But I was attracted by a recent roundtable with UK equity fund managers: "Brexit, the opportunities and risks".  The spiel turned into a pitch for their funds, though, which had performed well in recent years – I remarked at questions, benefiting from exceptional monetary stimulus since 2009.  

Did they see Brexit as net positive or net negative for their portfolios, at current valuations?  Can stock-picking defy its risks?  Have they sold stocks in anticipation, and which?   

I didn't really get specific answers, more a talking round the issues, as if fund managers are guessing like anyone else.  Maybe there's a situational bias: fund managers might as well stay invested, for if stocks go down their performance would be in line with the market, but they’d lag rivals if prices rise after selling.  

I also recall from a similar presentation in 2007, the managers back then were optimistic.  It's part of their job to maintain public confidence, especially open-ended funds where redemptions can force selling.

"Star fund manager" argues UK shares are undervalued

Richard Buxton is more forthright however.  As manager of Old Mutual's UK Alpha Fund he has made his own pitch to financial media, saying he is bullish on the UK economy despite "less than satisfactory handling" of Brexit talks so far.  

In fairness to the government it's very hard to satisfy all elements of the Tory party and the DUP, and also meet Brussels' requirement that we must fare less well outside the EU than in it, to discourage other countries from leaving.  But, despite Brexit worries and bad weather impacting Q1 to just 0.1% growth, Buxton thinks the squeeze on real incomes will reverse with inflation falling away and real wage growth coming through from a strong labour market, so look out for an interest rate rise in August.

Personally, I'd mind how inflation tends to lag shifts in sterling's value - linked mainly to Brexit - possibly creating a dilemma for the Bank of England.   

Consensus within its monetary policy committee does seem to be shifting towards a rise - a deputy governor saying in June "the period of unusually subdued growth in wages appears to be coming to an end" - but the consequences of a bad exit deal, or no deal, could further hurt business/consumer confidence.  Stagflation is, therefore, a risk, as short sellers would likely drive sterling down again thereby raising import costs.

Reasons also for resilience in UK and European equities 

The government's budget deficit figures remain better than expected thus, by the November budget, the Chancellor may be in a position to spend more - e.g. alleviating pressure on outsourcers, whose stock ratings have tended to anticipate downgrades.  

This may also catch the attention of international investors who are largely underweight UK equities, out of scepticism for Brexit.  Presently, the UK market's price/earnings (PE) multiple is some 14 times and yields over 4%, which is modest by international standards; although I'd mind these are historic ratings which could quite easily be blown away by events.  

A flip-side of negativity among portfolio investors, especially if sterling remains under pressure, is encouraging more foreign takeovers. This would support other stocks when the market realises a sector is under-priced.  

So, there are reasons to look beyond current despair about how UK negotiations appear to be tending towards a bad deal or no deal with the EU.

Meanwhile, Citibank's strategists contend that European equities will have surplus free cash flow available for dividends now that payout ratios have generally recovered; and economic growth will be robust after cumulative years of QE.  

I prefer to mind the actual statistics which for Europe are turning mixed.  This doesn't deter BNP Paribas strategists either, who reckon a recent "dovish" meeting of the European Central Bank could be followed by near-15% returns from European equities over the next six months as easy money policies extend.  

In a long-term context, however, central banks are trying to exit stimulus programmes, and it is late-cycle anyway in most economies, so I'd be wary about the ability of handing round more "candy floss" to boost equities if data is turning down.  Like with the fund managers, remember the investment banks' agenda is ultimately to promote stock.

Hopefully this will indeed all conflate into a summer holiday sell-off, generating trading and investment opportunities alike.  Markets don't appear able to shrug off the trade fears, which are festering.  Look forward to better value ahead!

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