Fade the What Again?!

Volatility (VIX) remains elevated as stocks tumbled to close the week lower by about 2% across U.S. and Europe. The week started with a push higher as markets continued to ignore the virus risks and it's economic impact. The flocking to Big Tech continued as NASDAQ hit a new all-time high on Tuesday's (23rd June) close.

The risk of rising cases caught up as some states reversed reopening plans and Fed's announcement to cap Bank share buyback and dividends managed to get some risk-off and pull the stock market lower.

Three charts and some data points that stood out during the third week of June (22nd to 26th June, 2020).

Fade the What Again?

Fade the US. We've heard this tape play over and over again since the past few years but the music has remained with US Equities domination. We can argue that everything in markets and economics follows cycles and hence this domination will end sometime, but when is the trillion-dollar question?

The below chart from Schroders wonderfully captures the drivers of US equity performance. Some points to note:

• Since the GFC , annualized return form US equities has been 13% compared to the 6% from Global equities ex US.
• Until 2015, the main reason for US out-performance was earnings growth which is denoted below by EPS growth (blue histogram bars). US Earnings grew 17% per year compared to 7% outside US.
• Since 2015, the main drivers shifted to Valuation Changes (think of buybacks, tax cuts and generally easy monetary policy) and the Strong Dollar.
• In the current crises, the Big Tech driven, US Valuations are being stretched even further. US share prices trade at 25 times their cyclically adjusted historical earnings (CAPE) compared to only 13 times for global equities. CAPE is price divided by average profits over the past 10 years.

Timing the shift from US is tough but it's something that I feel, will slowly start to happen over the next few years. Being open to looking at things other than US Technology and Consumer is the first step. Looking in the direction of China and Europe is probably the second step. In the past posts and articles, I have expressed my positive feeling from this newfound cooperation in Europe and I am excited to see what this will mean to asset returns.

A point on the weak dollar which will play a big part in taking away the shine of US Equities. Generally, while coming out of a recession, US Dollar weakness. This time the drivers for the weakness are more pronounced. Record Monetary printing and Fiscal deficits in the US, lack of wide interest rate differentials between US and other major economies and better management of the COVID-19 crises elsewhere, particularly Europe and Asia will make investors question the two-faced ultimate safe-haven status of the USD. Two-faced because USD is bid both during Risk-off and Risk-on times.

The key, I feel is that the weak dollar trade should be well underway and should lead the US Equities lower. There will be short term gyrations i.e, US equities lower, USD catching a bid due to risk aversion, but the medium/long term path for the USD seems lower.

Fed says No Buybacks and caps Dividends

In an announcement that showed that, apart from providing unstinting support to the US financial system, the Fed can indeed take one back and discipline US Banks, Fed barred buybacks, and capped dividends. Stress test results showed that the biggest banks might need to take up to $700 billion in losses due to the current pandemic induced economic downturn. Under the three scenarios:

• V-shaped - $560 billion in loan losses
• U-shaped - $700 billion in loan losses
• W-shaped - $680 billion in loan losses

Bank shares were up during normal trading hours on Thursday as Fed relaxed the Volcker Rule and allowed Banks to increase investment into venture capital fund and freed up capital that would have been otherwise dedicated as margin on derivative trades with their affiliates.

Banks turned lower after Fed barred third quarter share buyback and said dividends will be capped to the amount paid in the second quarter and is further limited to an amount based on recent earnings.

The chart below shows the extent of share price management by banks that has happened over the past few years and the past three years in particular. Banks have returned 140% of their profits in 2017, 100% in 2018, and 120% on 2019. 70% of bank shareholder distributions happen via buybacks. Instilling disciple is hence much needed.

Wirecard's big Big BIG drop!

These days we are so used to seeing charts with big cliff drops that I thought putting actual numbers in a table will make more sense to digest the extent of Wirecard's drop

Wirecard filed for insolvency proceedings, a first for a DAX 30 Index member after revealing that more than 1.9 billion Euro cash missing from its balance sheet probably didn't exist. A week ago Wirecard was a 13 billion Euro company and this week a few million. The 1.9 billion Euro cash missing is equivalent to all net income Wirecard has reported over more than a decade. Some stock analysts say that the stock hasn't hit zero due to technical reasons as some options and short positions need to unwind.

This is a reminder for investors that everything in digital payments is not a buy and the absolute fundamental is always Integrity. Stay away if you feel the slightest wobble.

Disclaimer: The views and opinions expressed, if any, are of my own and do not necessarily reflect the official policy or position of the organization I work for.