The US recorded more than 75,000 new COVID19 cases on July 16th. The CCP must be smiling behind their masks after successfully containing last month’s outbreak in Beijing.
Source JHU CSSE
Technology stocks have screamed upwards despite the chaos, but bearish divergence on Twiggs Money Flow now warns of selling pressure. Expect retracement to test support at 2650 on the Dow Jones US Technology Index.
Dow Jones Banks Index is a more realistic representation of the broader US economy. The weak rally has fizzled out, with a Money Flow peak at zero now warning of strong selling pressure. Breach of short-term support at 320 would signal another test of primary support at 270/280.
Government support can only cushion the impact of a massive surge in unemployment for a limited time. Then we will witness the full extent of the damage.
Continued unemployment claims jumped to 17.355 million on July 4th, up by 840,000 from a week earlier. Judging by the rising virus count, further increases are likely.
But that is only the tip of the iceberg.
The latest Department of Labor update shows 32 million people claimed unemployment insurance benefits in all programs for the week ending June 27.
…..21% of the 152.4 million non-farm workforce in February 2020.
Pandemic Unemployment Assistance (PUA) under the CARES Act, signed into law on March 27, 2020 provides benefits to those individuals “not eligible for regular unemployment compensation or extended benefits under state or Federal law or pandemic emergency unemployment compensation (PEUC), including those who have exhausted all rights to such benefits.”
The S&P 500 is inching upwards, reflecting the tug-of-war between technology stocks and the broader market. We expect retracement of the Technology Index to cause another test of support at 3000 (on the S&P 500).
I am fond off quoting Jesse Livermore’s maxim “You don’t argue with the tape” but Livermore was a keen student of market conditions and based his decisions on far more than just price action in the market.
We are witnessing a spectacular stock market rally, driven by retail investors and hedge funds piling into the market while institutional investors are sitting on the sidelines.
The Nasdaq 100 broke through resistance at 10,000, new highs signaling a fresh primary advance. Bearish divergence on Twiggs Money Flow index may warn of selling pressure but it is hard to argue with the tape. Only a fall below 9500 would signal another decline and that seems unlikely at present.
Even retail sales (ex food) have recovered sharply, from -15.3% in April to -1.4% in May (annual % gain).
Light vehicle sales are more sluggish but June sales of 13.05 million are still a sizable bounce.
So why are many old investment hands acting with such caution?
We know that the efforts to contain the COVID19 outbreak are struggling, with over 60,000 new cases per day, but the economy still seems in good shape.
Source JHU CSSE
Let’s look at where the money is coming from.
Treasury debt has expanded by more than $3 trillion in the last four months (March 9 – July 9) as the government does everything in its power to cushion the economy from an unprecedented shutdown. Rescuing airlines, bailing out Boeing, emergency business loans, job preservation schemes, and supporting Fed purchases of a wide variety of financial assets to keep the plumbing of financial markets open. Every way they can, government has been flooding the market with money and some of that has found its way to the stock market. Whether through boosting stock purchases, enabling companies to raise debt or boosting consumer spending to buoy up sales, the market is flying on borrowed money.
Steep up-trends like this typically end in a blow-off. A trend is self-reinforcing if rising prices attract more investors who in turn bid up prices even further. A steady influx of new investors is required to sustain the trend, else it dies.
Similar self-reinforcing cycles are evident in nature, where they expand violently outward at an exponential rate until they run out of fuel. The fuel driving the event may differ, from dry tinder in a forest fire, warm ocean temperatures in a hurricane, consumable vegetation in a locust plague, …..or exposed population in a virus outbreak. The cycle expands, feeding on itself, until the fuel is exhausted.
A stock market blow-off is no different. The up-trend will continue for as long as rising prices are able to attract new investors. It will stop when the source of new money dries up. In this case, when Treasury tries to slow the unsustainable growth in federal debt. Then it becomes a case of devil-take-the-hindmost as a preponderance of sellers attempt to offload their stocks on a rapidly shrinking pool of buyers.
COVID19 looks like it will be with us for some time. The US has to guard against a second wave, destroying any hard-won gains.
Especially with the upsurge in daily cases in Mexico.
Australia has been fortunate to catch the outbreak early.
But international travel is likely to remain restricted for a long time. When you have new outbreak hotspots like Brazil….
and Pakistan appearing on the radar.
|Stock:||Macquarie Group Ltd|
|Market Cap:||$38.8 bn||Fair Value:||$125.42|
|Forward P/E:||15.6||FV Payback (Years):||11|
|Forward Dividend Yield:||4.09%||CET1 Capital Ratio:||12.2%|
|Sector:||Financial Services||Industry:||Capital Markets|
|Investment Theme:||Dividends & Growth||LT Trends:||none|
We consider Macquarie (MQG) to be priced at below fair value, but the technical outlook is bearish.
We rate the stock as a long-term HOLD because of its strong cash flows and competitive position. Weighting is 5.0% of portfolio value.
We project flat annual revenue growth in the next 12 months, recovering to 8% in the long-term, with a provision of $1.5 billion to cover further impairment charges and under-performance of market-facing businesses. Estimated fair value is $125.42 with a payback period of 11 years.
The payback period recognizes MQG’s strong market position but also the uncertainty of financial markets.
MQG is in a primary down-trend and we expect another test of primary support at 70 before the bear market is over. Trend Index and Momentum below zero both warn of bearish market sentiment. Respect of primary support would provide a solid base for a new primary up-trend. Breach is unlikely but would flag another decline and a strong bear market.
Macquarie Group is Australia’s only sizable investment bank. Internationally diversified, the group employs 15,849 people in 31 countries, with its head office in Sydney, Australia.
Macquarie was innovative in setting up large infrastructure funds which provided a captive client for the group but most of these were dissolved after the 2008 global financial crisis and have been replaced as an income source by other annuity businesses. FY20 net profit contribution by activity:
Asset Management (MAM) manages infrastructure and real assets and securities investments for both retail and institutional clients in Australia and the US, with a total of $A607 billion under management in FY20.
Corporate and Asset Finance (CAF), with an asset and loan portfolio of $A21.3 billion (FY19) was broken up and integrated into MAM, CGM and Macquarie Capital in FY20.
Banking and Financial Services (BFS) has a retail deposit book of $63.9 billion, an Australian loan and lease portfolio of $A75.3 billion and a wealth management platform with funds of $A79.1 billion (FY20).
Commodities and Global Markets (CGM) offers broking, trading, hedging and finance on global securities markets including equities, fixed income, foreign exchange and commodities.
Macquarie Capital (MC) provides corporate finance advisory and capital raising services to corporate and government clients.
International income1 is net operating income excluding earnings on capital. Australia2 includes New Zealand.
Macquarie competes with local commercial banks, fund managers and securities houses, and — with 67% international income in FY20 — a multitude of international investment banks.
Annuity-based businesses performed well in FY20 but cyclical, market-facing divisions experienced a significant fall in net profit contribution.
- MAM assets under management grew 10% to $605.7bn in FY20, compared to $551bn in FY19;
- Banking & Financial Services (BFS) loans and leases grew 20% to $75.3 bn, funded by a 20% increase in deposits to $63.9 bn.
Market-facing businesses under-performed in terms of net profit contribution1 in FY20:
- Commodities and Global Markets (CGM) were level with FY19; while
- Macquarie Capital (MC) fell 75% after a stellar 89% increase in FY19.
Annuity-style businesses improved in FY20:
- Asset Management (MAM) was up 16%;
- Banking & Financial Services (BFS) were up 2%.
Net Profit Contribution1 is calculated before unallocated corporate costs, profit share and income tax.
Return on Equity
Return on equity fell to 13.6% due to an 88% increase in impairment charges ($1.04 bn compared to $552 m in FY19), related to the COVID19 outbreak and weak results from market-facing businesses.
Staff costs are Macquarie’s largest operating expense. Long-term growth in the ratio of Net Income to Employment Costs reflects Macquarie’s increased ability to leverage operating expenses.
Assets under management
Assets under management have grown at a compound annual rate of 6.4% over the last 10 years (FY10 to FY20).
Earnings per share
Earnings per share (EPS) has grown at a compound annual rate of 8.6% over the last 10 years or 9.6% over the last 5 years.
We project long-term growth of 8% in annuity-based assets (AM, BFS & CAF) and in earnings per share.
CET1 (Common Equity Tier 1) Capital Ratio improved to 12.2% in FY20 (FY19: 11.4%) calculated on risk-weighted assets using APRA Basel III standards.
The unweighted CET1 Leverage Ratio, based on total credit exposure, however, weakened to 5.1% in FY20 .
Capital ratios are adequate but not strong by our standards.
Dividend payout of $4.30 (40% franked) for FY20 is down 25% compared to FY19 ($5.75 and 45% franked). We consider the dividend payout ratio of 56% (FY20) to be sustainable.
Guidance for FY21 has been withheld because of uncertainty surrounding the COVID19 outbreak.
We have made a provision of $1.5 billion to allow for uncertainty over further impairment charges and under-performance of market-facing businesses.
Strengths & weaknesses
Macquarie is a world-leading infrastructure fund manager and in an excellent position to capitalize on massive expected investment in global infrastructure and renewable energy over the next decade.
Like most investment banks, Macquarie relies on market knowledge and resourcefulness to identify new opportunities and innovate existing businesses. While they have an excellent track record, they can still make mistakes.
Cyclical fluctuations may affect performance.
BFS exposure to the highly-priced Australian property market is a vulnerability.
Staff of The Patient Investor may directly or indirectly own shares in the above company.
|Market Cap:||$1.3 Tn||Fair Value:||$181.52|
|Forward P/E:||25.06||FV Payback (Years):||11|
|Forward Dividend Yield:||1.10%||Debt/FCF:||2.1|
|Investment Theme:||LT Growth||Structural Trends:||Growth of online services|
We consider Apple (AAPL) to be priced above fair value, but the technical outlook is bullish.
We rate the stock as a HOLD but have not included it in our model portfolio because of declining long-term revenue growth.
We project annual revenue to fall 15% in the next 12 months, recovering to 7% growth in the long-term. Estimated fair value is $181.52 with a payback period of 11 years.
The payback period recognizes AAPL’s strong market position but also its reliance on continuing sales of devices (as opposed to services).
AAPL continues in a primary up-trend, but expect strong resistance at its Feb high of 325. A Declining Trend Index warns of secondary selling pressure. Respect of resistance at 325 would suggest another test of primary support at 230.
Apple was a pioneer of the personal computer revolution, introducing the Macintosh in 1984. Today, Apple is a world leader in five areas of consumer electronics:
- iPhone smart phones;
- iPad tablets;
- Mac computers;
- Apple Watch; and
- Apple TV.
Apple devices run internally developed semiconductors and software platforms — iOS, iPadOS, macOS, watchOS, and tvOS — with an enviable reputation for connectivity across all Apple devices.
Products are sold online, through company-owned stores, and through third-party retailers. Apart from device sales, about 20% of revenue is derived from services, including:
- the App Store;
- Apple Music;
- Apple Pay; and
Apple’s headquarters are in Cupertino, California and the corporation employs more than 100,000 people.
Morningstar sums up Apple’s competitive strengths:
We assign a narrow economic moat rating for Apple that stems from the combination of switching costs and intangible assets. We think the firm’s primary moat source is customer switching costs, as Apple bolsters the user experience with a cohort of auxiliary products…….
Regarding intangible assets, Apple’s differentiated user experience via iOS coupled with its expertise in both hardware and software design allows the firm to more seamlessly build integrated products.
….Recent survey data shows that iPhone customers are not even contemplating switching brands today. In a December 2018 survey by Kantar, 90% of U.S.-based iPhone users said they planned to remain loyal to future Apple devices. Also, users of ancillary products (especially the Watch and AirPods) lose significant functionality when paired with a smartphone other than the iPhone. Ultimately, we believe that existing iPhone users are relatively locked in to the iOS ecosystem and interface.
Major competitors include Samsung (Galaxy) which, coupled with Google (Android OS), dominates market share in smartphones. But neither offer an integrated suite of products that can compete with Apple.
Apple sales are dominated by iPhone but there is little year-on-year growth.
Growth is concentrated in the Services and Wearables segments.
Geographically, sales in the US are growing fastest, while China declined in FY19.
Apple is losing market share in China as local smartphone technology improves. From The Wall Street Journal:
Apple’s share of the Chinese smartphone market has been shrinking, crowded out by tech giants such as China’s Huawei Technologies Co. that market increasingly sophisticated phones at a lower price tag.
Apple’s share of the Chinese smartphone market contracted to 7.8% in the first three quarters of 2018 from a peak in 2015 of 12.5%, according to Canalys, a market research firm.
Revenue growth and operating cash flows have been disappointing in FY19 and FY20 so far. We expect a 15% fall in the next 12 months due to the impact of the coronavirus outbreak and declining sales in China.
Thereafter we expect annual growth to recover to 7% in the long-term.
Declining operating margins reflect an increasingly competitive environment.
Capital expenditure declined as a percentage of sales, suggesting limited growth opportunities.
Stock buybacks reduced shares outstanding by 32% since FY12.
A further $50 billion has been authorized for the year ahead.
Buybacks from FY13 to FY17 were largely funded by debt.
Debt at $99.5 billion (Q2 FY20), or 2.1 times projected free cash flow, however, remains comfortable when compared to cash & marketable investments of $156.8 billion.
Apple did not issue guidance for the quarter ending in June, as it usually does, due to uncertainty from the coronavirus outbreak.
Staff of The Patient Investor may directly or indirectly own shares in the above company.
The view is often promoted that low GDP growth over the past decade is caused by low interest rates and balance sheet expansion (QE) by central banks. That is putting the cart before the horse. Central banks have tried to stimulate their economies, with massive QE and low interest rates, because of low GDP growth. Not the other way around.
The real cause of low GDP growth is low job growth, as the chart below illustrates.
[click here for full screen image]
Offshoring jobs means offshoring growth.
The last time that the US had employment growth above 5.0% is 1984 which also the last time that we saw real GDP growth at 7.5%. Since then, job growth has progressively weakened — and GDP with it.
In the last decade, employment growth peaked at 2.27% and GDP at 3.98% in Q1 of 2015.
We now expect job growth to fall to -20% in April, four times the -5% trough in 2009, and a sharp GDP contraction.
How long the recession/depression will continue is uncertain. But, in the long-term, it is unlikely that the US can achieve +5% real GDP growth unless employment growth recovers close to +3.0%.
Initial jobless claims in the US for the 6 weeks to April 25th exceed 30 million.
That will take unemployment above 20%, with total jobs falling to levels last seen in 1997, and more job losses still to come.
Employment is the key to economic recovery. While unemployment is high, consumer spending will stay low and the economy will struggle. Companies may receive bailouts and the Fed will keep financial markets awash with liquidity but that does not help falling sales.
Be prepared. April employment numbers are going to be ugly. Expect some turbulence.
On the weekend we wrote that the bottom had fallen out of the oil market after Nymex crude broke support at $20 per barrel.
Now, the previously unimaginable has occurred, with Nymex Light Crude falling below zero for the first time in history, closing at -$13.10 per barrel with reports of intra-day lows at -$37.63.
From The Age:
“Traders are still paying $US20.43 for a barrel of US oil to be delivered in June, which analysts consider to be closer to the “true” price of oil. Crude to be delivered next month, meanwhile, is running up against a stark problem: traders are running out of places to keep it, with storage tanks close to full amid a collapse in demand as factories, automobiles and airplanes sit idled around the world.
Tanks at a key energy hub in Oklahoma could hit their limits within three weeks, according to Chris Midgley, head of analytics at S&P Global Platts. Because of that, traders are willing to pay others to take that oil for delivery in May off their hands, so long as they also take the burden of figuring out where to keep it.”
Brent Crude is trading at $25.57 per barrel but a Trend Index peak deep below zero warns of similar strong selling pressure.
Crude oil production is still in a long-term up-trend. Low prices may present opportunities to buy cyclical stocks at historically low prices.
The Oil & Gas sector has plunged as expected.
Oil infrastructure is also suffering from low activity levels.
Energy-consuming industries, however, may benefit from lower oil prices.
Transport is the biggest consumer of crude oil products.
If we break usage down by fuel types, the largest is diesel/gas, followed closely by motor gasoline, with jet kerosene significantly smaller.
Airlines which have suffered from a massive drop in air travel.
While delivery services (formerly air freight) are suffering from the collapse of global trade.
So is marine transport.
But trucking is holding up well.
Crude oil runs a distant second to coal as the chief energy source for cement production.
But the industry is a heavy transport user and should benefit from lower oil prices.
Mining is also likely to benefit from lower extraction and transport costs.
Forestry & Paper
Forestry is another heavy fuel user.
Chemicals & Plastics
Basic chemicals (including fertilizers) are the largest industrial consumer of crude oil.
Specialty chemicals are also largely oil-based.
Aerospace & Automobiles
Aerospace, laid low by problems at Boeing (BA), has been floored by a massive downturn in the airline industry and will take a long time to recover.
Automobiles have so far stood up well because of stellar performance from the likes of Tesla (TSLA).
But the sting is in the tail. Light vehicle sales have plummeted.
Low vehicle sales and less travel also means lower tire sales.
Oil Producers in Affected Regions
The IEA graph below shows producing regions that are uneconomic at varying prices/barrel (x-axis). If we take $25/barrel as the average over the next two years, North American producers would suffer the most, followed by Asia-Pacific and Latin America.
Middle-Eastern producers enjoy the lowest extraction costs and are mostly still profitable at lower prices.
Avoiding Value Traps
Value opportunities abound in industries that are badly affected by the economic contraction and falling crude prices — as well as by those industries that stand to benefit from low oil prices. Some affected industries, however, are going to struggle to survive without state assistance.
The problem with value stocks is that, although they may seem cheap, prices can fall a lot further. That is why we use both technical and fundamental analysis to evaluate opportunities.
There are many stocks that are trading well below our assessment of fair value at present but we will not buy until the technical outlook turns bullish. It takes plenty of patience. But helps to avoid value traps.
The stock market remains an exceptionally efficient mechanism
for the transfer of wealth from the impatient to the patient.
~ Warren Buffett