Your Daily Guide to Markets, Data and Disruption

DATATREK MORNING BRIEFING

June 23, 2019

Nicholas Colas, Co-founder
nick@datatrekresearch.com
Jessica Rabe, Co-founder
jessica@datatrekresearch.com

Prepared only for: John Schipper, jschipper@conestogacapital.com

IN TODAY'S EDITION

Markets: How much more can US equity valuations expand as interest rates continue to drop? An analysis of German/Japanese equities says “not at all”, even though sovereign rates there are negative. Further, S&P 500 valuation history from 2012 and 2016 (when 10-year Treasuries were below 2.0%) agrees; multiples were either lower (2012) or the same (2016) as now. Bottom line: we’re near the top of rate-driven P/E multiple revisions, and now it will be up to earnings/trade talks to propel markets higher.

Data: Gold broke out to a +5 year high last week and now sits at $1,400/ounce. The central reason: storing capital here is now cheaper than buying sovereign debt like German bunds. Also in the mix: central bank buying, which has been strong this year after an already robust 2018, as well as stable supply and a weaker dollar. We’ve always been in the camp that favors a 3-5% portfolio holding in gold, but after a 5-year stretch of underperformance the yellow metal should finally start to earn its keep.

Disruption: MSCI is in the middle of upping the weighting for Chinese A-Shares in its widely followed Emerging Markets Index. As the US – China trade war continues to heat up, that’s not sitting well with DC policymakers. Senator Marco Rubio recently sent a letter to MSCI asking about their due diligence ahead of this decision, highlighting how little outsiders really know about Chinese state-controlled companies. A good chunk of Chinese disruptive tech gets funded via US IPOs, so this vector is worth watching.

Plus our usual roundup of market action, curated links, and mind candy.

(Stock) Love In A Time of Zero Rates

It’s not just the S&P 500 hitting a new record last week: data from Bloomberg shows the dollar amount of global debt sporting negative yields broke to a new high as well. The data (link at the end of this section):

• $13 trillion of global debt now has a negative yield, assuring a nominal loss for any buyers at current levels.

• It’s not just German and Japanese sovereigns in the mix here. Austrian, French and Swedish 10-years hit new negative yield levels.

• A quarter of that $13 trillion is in the corporate debt market.

On paper, this should be fantastic for global equity valuations and also help boost US stocks:

• As yields decline, the discount rate used to value future corporate cash flows should drop as well.

• The math here is simple enough. At a 7% discount rate, for example, $100/year of cash flow is worth $1,429 ($100/0.07). Drop the risk free rate by 1.0 percentage point and the same $100/year is worth $1,667 ($100/0.06). That’s a 17% increase in value ($238) even though cash flows are unchanged.

• No coincidence, therefore, that the S&P 500 is +18% in 2019 as 10-year yields have dropped by 73 basis points from their January highs (2.78%) to now (2.06%)

The question now: “How much can negative yields help valuations from here?” We pulled a few case studies to answer that question.

Case Study #1: Japan, the country most associated with negative interest rates:

• Current 10-year JGB yield: -0.17%
• Current forward Price/Earnings ratio for the MSCI Japan Index: 12.6x
• YTD/One year return for MSCI Japan in dollar terms: +7.4%, -7.5%

Verdict: Even at near-zero/negative rates, Japan has seen both lackluster equity returns over the last year and low valuations relative to US equities (S&P 500 trading for 16.8x).

Case Study #2: Germany, the epicenter of the current global trend to negative yields:

• Current 10-year Bund yield: -0.28%
• Current forward P/E ratio for the MSCI Germany Index: 12.3x
• YTD/One year return for the MSCI German Index in dollar terms: +9.5%, -9.4%

Verdict: Same as Japan – even the recent move to negative rates has not put a fire under German equities (1-month returns -0.4%).

Case Study #3: the US in 2012 and 2016, when Treasuries saw their all-time lowest yields:

• 2012 average daily 10-year Treasury yield: 1.80%.
  
  S&P 500 total return in 2012: 15.9%. Average forward P/E ratio (per FactSet): 12.0x.

• 2016 average daily 10-year Treasury yield: 1.84%
  
  S&P 500 total return in 2016: 11.8%. Average forward P/E ratio: 16.5x.

• Worth noting; S&P 500 earnings grew by 6.0% in 2012 but just 0.5% in 2016

Verdict: the 2 years with the lowest Treasury yields saw valuations either lower (12.0x) or the same (16.5x) as today. Rates in 2012 and 2016 were modestly lower than Friday’s 2.06% close. US stocks still worked, but largely because of hopes for cyclically improving earnings.

The bottom line: there are clearly diminishing returns from ever-lower long run interest rates when it comes to how they inform equity valuations. Current valuations for German/Japanese equities show that outright negative rates do not help; both trade at sizable discounts to US stocks even though Treasuries pay much larger coupons. And when Treasury yields dip below 2.0%, as they did in 2012 and 2016, valuations don’t get much higher than today.

Why don’t yields help in the way simple valuation math says they should? We’ll wrap up with 3 ideas on this point:

• Negative rates are a sign that the transmission mechanism between monetary policy and the real economy is broken. Economic actors and market participants are therefore reluctant to spend and/or invest.

• They also signal that deflationary pressures are building, potentially reducing consumption and therefore future earnings power.

• Looking just at today’s situation, negative sovereign debt yields push capital into riskier corporate debt at a time when this asset class may already be over-stretched. In the US, for example, total corporate debt is 48% of GDP, an all time record. This “crowding in” phenomenon makes the economy more fragile and threatens earnings stability in the next downturn.

The upshot from all this: history says don’t look for multiple expansion as global rates plumb fresh lows. Equity returns - in the US and elsewhere – will have to come from earnings growth now. All that puts extra pressure on the Trump/XI meeting at the G20 meeting later this week.

Sources:
Bloomberg article: https://www.bloomberg.com/news/articles/2019-06-21/the-world-now-has-13-trillion-of-debt-with-below-zero-yields?utm_campaign=socialflow-organic&cmpid%3D=socialflow-twitter-markets&utm_medium=social&utm_content=markets&utm_source=twitter

Global equity valuations: https://www.yardeni.com/pub/mscipe.pdf

DAILY DATAPOINT

Gold is breaking out after a very long stretch of inactivity:

• Friday’s close at $1,400/oz puts the yellow metal at +8.9% on the year.

• The last time gold was at similar levels was in mid 2013.

• Over the last 5 years it has meandered between $1,075-ish (Q4 2015) and just over $1,350 (mid 2016, September 2017, and early 2018).

So what’s going on? Three points to consider:

#1. The current global rate reset helps…

• As noted in the Markets section there is some $13 trillion of negative yielding debt around the world, a new record that coincides with gold’s recent Lazarus-like move.

• Since gold pays no dividend and costs money to store, its theoretical attractiveness as a store of value increases when interest rates drop through zero.

• The expense ratios for the GLD (SPDR Gold Shares ETF) and IAU (iShares Gold Trust) ETFs are reasonable proxies for storage expense, at 40/25 basis points respectively.

• That puts the average gold holding cost at 33 bp, not far off German 10-year Bunds (-28 bp) and actually cheaper than all German sovereign debt with maturities less than 10 years (-37 to -77 bp).

Takeaway: It is actually cheaper to store capital in gold than in some liquid financial assets just now. Yes, there is capital risk. But remember that gold has been relatively stable over recent memory, so buyers may well feel that this is a risk worth taking.

#2: … And so does market sentiment that the Federal Reserve will be cutting interest rates, causing a further decline in the value of the dollar:

• Gold, like oil, is largely priced in dollars across all major global end markets. A strong dollar hurts its affordability, whether you are talking Indian wedding gifts (an important source of demand) or buyers’ interest from Greater China.

• Measured by the DXY Index the dollar dropped by 1.5% last week, its largest 5-day decline of the year. Still, it would take a further drop of 2.3% just to take it to 1-year low levels.

Takeaway: currency and gold markets were late to the party in terms of expecting a more dovish Fed but are now making up for lost time. Fed Funds Futures markets were, as we have repeatedly highlighted in these notes, first in the door and now other capital markets (stocks included) are catching up.

#3: As far as near-term sources of gold demand, the Q1 World Gold Council Demand Trends report shows one interesting buyer:

• Global gold demand grew by 7% in Q1 2019 against an easy comp. Q1 2018 demand was at a 3-year low.

• Central bank buying was the largest source of “surprise” demand, up 146 tons and the largest add for any Q1 back to 2013 when it comes to this sort of buyer.

• ETF demand was also good, up 49% year-over-year, but industrial demand (mostly from the Tech industry) hit a 2-year low. There is an average of 0.034 grams of gold in every cell phone, by the way…

• Gold supply, both newly mined and recycled, was flat in Q1.

Takeaway: global central banks – think Russia and Turkey – have been the marginal buyer for gold not just in Q1 but last year as well. That they bought more in Q1 than usual for this period indicates they are not likely done with their purchases. The “barbarous relic” may not be a part of how western central banks consider policy, but it still clearly plays a role elsewhere.

Summing up: gold is getting a lot of buzz just now and it’s easy enough to see why. Buoyed by lower global rates and continued central bank buying, the runway looks clear. From an investment standpoint, we’re in the camp that says a 3-5% weighting in gold is prudent. But unlike the last 5 years, such a position should now actually earn its keep.

Sources:
World Gold Council report: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2019

DAILY DISRUPTION FEATURE

Ten days ago US Senator Marco Rubio sent a letter to the Chair/CEO of MSCI, the global index provider, questioning the inclusion/increased weighting of Chinese “A-share” companies in the MSCI Emerging Markets Index. His points:

• Since the index is available to US investors (through popular ETF products like iShares’ EEM, for example), American policymakers/regulators have responsibility for ensuring that its holdings meet basic disclosure and reporting requirements.

• Chinese A-shares in particular are a pretty opaque group of companies, and Rubio’s letter says “MSCI acknowledges that 58% of the constituents in the A-shares Index are controlled by the Chinese state.”

• Rubio asks MSCI if they performed enough due diligence to know who holds the debt/equity of these companies and if the Chinese government could assert influence or control over them. He also asks if MSCI’s research extended to ascertaining if these companies are military contractors, enabling the Chinese government crackdown of the local Uygher population, or engaged in cyber espionage among other questions.

This initial salvo went largely unnoticed, but the South China Morning Post ran a story about it over the weekend after speaking directly with Senator Rubio. There’s a link in the section below, but when asked essentially “why do this now?” his reply was that President Trump’s China trade policy makes MSCI’s decision to increase A-share weightings highly problematic. Why would the US open its capital markets even further to a country it feels doesn’t work within international norms?

As much as this may look like a political stunt ahead of the upcoming Trump/Xi trade meeting at the end of the week, we wouldn’t entirely dismiss it. Here’s why:

• Even with the chill caused by the US-China trade dispute, Chinese companies do clearly benefit from access to American capital markets. While China IPOs are down dramatically versus last year, Luckin Coffee recently raised $560 million in a NASDAQ IPO, for example.

• When viewed through an ESG (environmental, social, and governance) lens, Rubio actually makes a very fair point. MSCI’s decision to up the “inclusion factor” for Chinese A-shares from 5% to 20% in three stages this year makes the Emerging Markets Index harder to evaluate on an ESG basis. All the recent analysis of Huawei’s possible ties to the Chinese Communist Party has highlighted just how little outsiders know about even some of China’s largest and most globally important companies.

• Thanks in part to changes in Hong Kong Stock Exchange listing requirements, Alibaba is reportedly pursuing a capital raise/listing there later this year. Right now, it is only listed in the US but it certainly makes sense for the company to trade in a market where retail investors may also be customers. And it’s a good hedge against further changes in US policy with respect to Chinese access to American capital markets.

Bottom line: We’re surprised it took this long for Washington to figure out that the Chinese economy benefits from access to US capital markets. Big tariffs on goods but no restrictions on capital investment seemed odd. It is telling that the first shot came from a critique of MSCI, an index provider, rather than jawboning about individual company listings. One more sign, it seems, that indexes are what gets attention now. Not stocks.

Sources:
Rubio’s letter to MSCI: https://www.rubio.senate.gov/public/index.cfm/press-releases?ContentRecord_id=C8851CBD-9AA2-45BC-85D3-619647A64D75

TODAY'S MARKET RECAP

US equities reached record highs on Friday, but ended slightly lower. Large caps bested small caps: S&P 500 (-0.13%) vs. Russell 2000 (-0.89%).

Energy (+0.82%) and utilities (+0.47%) outperformed the broader market indices, while real estate (-1.10%) and industrials (-0.51%) lagged. Disney (-1.26%) and Dow Inc (-1.16%) weighed on the Dow (-0.13%); UnitedHealth (+1.82%) and Exxon Mobil (+1.41%) were the index's best performers.

The Nasdaq edged down 0.24%, while tech lost 0.47%. The "FAANG" stocks were mixed: Facebook (+0.85%), Amazon (-0.36%), Apple (-0.34%), Netflix (+1.10%), Alphabet (+0.94%).

The VIX gained 4.41% to 15.40. The 30-year and 10-year Treasury yields increased to 2.586% and 2.059% respectively, while the 2-year yield rose to 1.772%. The difference between 2-Year and 10-Year Treasuries is at 29 basis points. History shows that once the Treasury yield curve inverts (10s yield less than 2s) a US recession is likely.

If you missed today's market action, here is a useful summary by CNBC.

TODAY'S CURATED LINKS

Must Read of the Day: "Vice President Pence will delay a speech detailing the administration's policies toward China until after the Group of 20 (G-20) summit, an administration official confirmed Friday. Pence was scheduled to deliver remarks on Monday elaborating on actions the U.S. would like to see China take. Instead, the vice president will hold off amid signs of progress before President Trump and Chinese President Xi Jinping meet at next weekend's summit in Osaka, Japan." Source: The Hill

"US Senator Marco Rubio is using the trade impasse between Washington and Beijing to open a new front of potential friction between the two nations, by questioning why a major player in global stock benchmarks is including Chinese shares in its stock indexes – years after that process has been under way. In a June 12 letter to Henry Fernandez, the chairman and chief executive officer of MSCI, Rubio questioned why the China A-shares class of stock, which trade in mainland China and typically are only available to mainland Chinese citizens, are being included in the company’s global indices, which overall serve as benchmarks to US$14.8 trillion in equity assets." Source: SCMP

"President Trump approved an offensive cyberstrike that disabled Iranian computer systems used to control rocket and missile launches, even as he backed away from a conventional military attack in response to its downing Thursday of an unmanned U.S. surveillance drone... The cyberstrikes, launched Thursday night by personnel with U.S. Cyber Command, were in the works for weeks if not months, according to two of these people, who said the Pentagon proposed launching them after Iran’s alleged attacks on two oil tankers in the Gulf of Oman earlier this month." Source: The Washington Post

"The U.S. Commerce Department has banned five more Chinese entities from buying U.S. components after blacklisting telecom giant Huawei last month. Higon, Chengdu Haiguang Integrated Circuit, Chengdu Haiguang Microelectronics Technology, Sugon and Wuxi Jiangnan Institute of Computing Technology are the five Chinese firms added to the department’s entity list, according to a filing. The department said the activities of these companies 'pose a significant risk of being or becoming involved in activities contrary to the national security and foreign policy interests of the United States'.” Source: CNBC

"At a recent event hosted for founders by the venture firm Village Global, one of its most prominent investors, Bill Gates, sat down with Eventbrite cofounder and CEO Julia Hartz to discuss founding a company and the tough decisions necessary at nearly every turn in order to create and sustain a thriving enterprise... Gates is still kicking himself for taking his eyes off the ball and allowing Google to develop Android, the 'standard non-Apple phone form platform,' as he describes it. 'That was a natural thing for Microsoft to win'.” Source: TechCrunch

"President Donald Trump said he never threatened to demote Federal Reserve Chairman Jerome Powell, though he maintained he has the authority to do so. 'I didn’t ever threaten to demote him,' Trump said in an interview with NBC’s 'Meet The Press' that broadcasted Sunday. 'I’d be able to do that if I wanted, but I haven’t suggested that.' 'I have the right to do that, but I haven’t said that,' the president continued. Trump went on to criticize the Federal Reserve for raising interest rates, saying Chairman Powell made a mistake." Source: CNBC

"China’s largest ride-hailing player, has opened its platform to rival companies allowing users to hail a car from third-party service providers as the battle to build the biggest and best super mobility app in the country heats up. The Beijing-based company’s moves comes as rivals Meituan Dianping and AutoNavi, both of which already offer one-stop spontaneous ride-hailing services from multiple dispatchers, continue to expand their operations." Source: SCMP

"With its acceleration of Prime shipping from two days to one, Amazon established a new normal. Soon after, Walmart and Target came out with their own super-speedy shipping options. Why it matters: Flying, trucking and delivering millions of packages a day comes with a cost — as shoppers demand faster and faster speed, there has been a sharp environmental impact. The big picture: Consumers have gotten hooked on speed — and the efficiencies that e-commerce injected into retail are getting erased because now there are more deliveries of smaller numbers of packages." Source: Axios

MIND CANDY

The new AR game Harry Potter: Wizards Unite came out on Thursday and was installed +400,000 times in its first 24 hours in the US and UK. That translated into about $300,000 in gross player spending across iOS and Android. It has not been as big a hit as Pokémon GO, however, which grossed $1.6 million in those two markets over that time frame. Still it's expected to reach $100 million in consumer spend in its first 30 days, which Pokémon GO earned in two weeks.

Source: TechCrunch

Spread the word!

For every person you refer to subscribe to our DataTrek Morning Briefings, we will give you and our new paying customer a $50 Amazon gift card each as a token of our gratitude.

**Just email jessica@datatrekresearch.com the name and email of your referral after they subscribe and we'll send you both a gift card asap. As always, thank you for your support!

**New readers can get a 2-week (no credit-card) free trial at datatrekresearch.com.

Questions or Comments? Reach us at: info@datatrekresearch.com
Visit our website at: datatrekresearch.com

DataTrek Research, LLC (“DataTrek”) is making the material, data and information (collectively “DataTrek Information”) contained in this email newsletter (this “Newsletter”) available to its subscribers for informational purposes only. The DataTrek Information is not intended to provide tax, legal or investment advice, and does not constitute a suggestion, solicitation or offer to purchase or sell securities. DataTrek believes that the DataTrek Information is reliable, but does not warrant its completeness or accuracy. DataTrek assumes no duty to update such information. Subscribers should carefully read the DataTrek Terms of Service, Privacy Policy and Subscription Agreement, including accompanying documentation, as those documents contain important information and disclosures about the products or services covered thereby. These documents are available at http://datatrekresearch.com/terms-of-service-for-datatrek-research-services/, http://datatrekresearch.com/subscription-agreement-eula/, and http://datatrekresearch.com/datatrek-research-privacy-policy. DataTrek Information is subject to change at any time. DataTrek is not responsible for third-party information or services, including market data from any securities exchange.

Unsubscribe

DataTrek Research 350 West 57th Street New York, New York 10019 United States

Your Daily Guide to Markets, Data and Disruption

DATATREK MORNING BRIEFING

June 23, 2019

Nicholas Colas, Co-founder
nick@datatrekresearch.com
Jessica Rabe, Co-founder
jessica@datatrekresearch.com

Prepared only for: John Schipper, jschipper@conestogacapital.com

IN TODAY'S EDITION

Markets: How much more can US equity valuations expand as interest rates continue to drop? An analysis of German/Japanese equities says “not at all”, even though sovereign rates there are negative. Further, S&P 500 valuation history from 2012 and 2016 (when 10-year Treasuries were below 2.0%) agrees; multiples were either lower (2012) or the same (2016) as now. Bottom line: we’re near the top of rate-driven P/E multiple revisions, and now it will be up to earnings/trade talks to propel markets higher.

Data: Gold broke out to a +5 year high last week and now sits at $1,400/ounce. The central reason: storing capital here is now cheaper than buying sovereign debt like German bunds. Also in the mix: central bank buying, which has been strong this year after an already robust 2018, as well as stable supply and a weaker dollar. We’ve always been in the camp that favors a 3-5% portfolio holding in gold, but after a 5-year stretch of underperformance the yellow metal should finally start to earn its keep.

Disruption: MSCI is in the middle of upping the weighting for Chinese A-Shares in its widely followed Emerging Markets Index. As the US – China trade war continues to heat up, that’s not sitting well with DC policymakers. Senator Marco Rubio recently sent a letter to MSCI asking about their due diligence ahead of this decision, highlighting how little outsiders really know about Chinese state-controlled companies. A good chunk of Chinese disruptive tech gets funded via US IPOs, so this vector is worth watching.

Plus our usual roundup of market action, curated links, and mind candy.

(Stock) Love In A Time of Zero Rates

It’s not just the S&P 500 hitting a new record last week: data from Bloomberg shows the dollar amount of global debt sporting negative yields broke to a new high as well. The data (link at the end of this section):

• $13 trillion of global debt now has a negative yield, assuring a nominal loss for any buyers at current levels.

• It’s not just German and Japanese sovereigns in the mix here. Austrian, French and Swedish 10-years hit new negative yield levels.

• A quarter of that $13 trillion is in the corporate debt market.

On paper, this should be fantastic for global equity valuations and also help boost US stocks:

• As yields decline, the discount rate used to value future corporate cash flows should drop as well.

• The math here is simple enough. At a 7% discount rate, for example, $100/year of cash flow is worth $1,429 ($100/0.07). Drop the risk free rate by 1.0 percentage point and the same $100/year is worth $1,667 ($100/0.06). That’s a 17% increase in value ($238) even though cash flows are unchanged.

• No coincidence, therefore, that the S&P 500 is +18% in 2019 as 10-year yields have dropped by 73 basis points from their January highs (2.78%) to now (2.06%)

The question now: “How much can negative yields help valuations from here?” We pulled a few case studies to answer that question.

Case Study #1: Japan, the country most associated with negative interest rates:

• Current 10-year JGB yield: -0.17%
• Current forward Price/Earnings ratio for the MSCI Japan Index: 12.6x
• YTD/One year return for MSCI Japan in dollar terms: +7.4%, -7.5%

Verdict: Even at near-zero/negative rates, Japan has seen both lackluster equity returns over the last year and low valuations relative to US equities (S&P 500 trading for 16.8x).

Case Study #2: Germany, the epicenter of the current global trend to negative yields:

• Current 10-year Bund yield: -0.28%
• Current forward P/E ratio for the MSCI Germany Index: 12.3x
• YTD/One year return for the MSCI German Index in dollar terms: +9.5%, -9.4%

Verdict: Same as Japan – even the recent move to negative rates has not put a fire under German equities (1-month returns -0.4%).

Case Study #3: the US in 2012 and 2016, when Treasuries saw their all-time lowest yields:

• 2012 average daily 10-year Treasury yield: 1.80%.
  
  S&P 500 total return in 2012: 15.9%. Average forward P/E ratio (per FactSet): 12.0x.

• 2016 average daily 10-year Treasury yield: 1.84%
  
  S&P 500 total return in 2016: 11.8%. Average forward P/E ratio: 16.5x.

• Worth noting; S&P 500 earnings grew by 6.0% in 2012 but just 0.5% in 2016

Verdict: the 2 years with the lowest Treasury yields saw valuations either lower (12.0x) or the same (16.5x) as today. Rates in 2012 and 2016 were modestly lower than Friday’s 2.06% close. US stocks still worked, but largely because of hopes for cyclically improving earnings.

The bottom line: there are clearly diminishing returns from ever-lower long run interest rates when it comes to how they inform equity valuations. Current valuations for German/Japanese equities show that outright negative rates do not help; both trade at sizable discounts to US stocks even though Treasuries pay much larger coupons. And when Treasury yields dip below 2.0%, as they did in 2012 and 2016, valuations don’t get much higher than today.

Why don’t yields help in the way simple valuation math says they should? We’ll wrap up with 3 ideas on this point:

• Negative rates are a sign that the transmission mechanism between monetary policy and the real economy is broken. Economic actors and market participants are therefore reluctant to spend and/or invest.

• They also signal that deflationary pressures are building, potentially reducing consumption and therefore future earnings power.

• Looking just at today’s situation, negative sovereign debt yields push capital into riskier corporate debt at a time when this asset class may already be over-stretched. In the US, for example, total corporate debt is 48% of GDP, an all time record. This “crowding in” phenomenon makes the economy more fragile and threatens earnings stability in the next downturn.

The upshot from all this: history says don’t look for multiple expansion as global rates plumb fresh lows. Equity returns - in the US and elsewhere – will have to come from earnings growth now. All that puts extra pressure on the Trump/XI meeting at the G20 meeting later this week.

Sources:
Bloomberg article: https://www.bloomberg.com/news/articles/2019-06-21/the-world-now-has-13-trillion-of-debt-with-below-zero-yields?utm_campaign=socialflow-organic&cmpid%3D=socialflow-twitter-markets&utm_medium=social&utm_content=markets&utm_source=twitter

Global equity valuations: https://www.yardeni.com/pub/mscipe.pdf

DAILY DATAPOINT

Gold is breaking out after a very long stretch of inactivity:

• Friday’s close at $1,400/oz puts the yellow metal at +8.9% on the year.

• The last time gold was at similar levels was in mid 2013.

• Over the last 5 years it has meandered between $1,075-ish (Q4 2015) and just over $1,350 (mid 2016, September 2017, and early 2018).

So what’s going on? Three points to consider:

#1. The current global rate reset helps…

• As noted in the Markets section there is some $13 trillion of negative yielding debt around the world, a new record that coincides with gold’s recent Lazarus-like move.

• Since gold pays no dividend and costs money to store, its theoretical attractiveness as a store of value increases when interest rates drop through zero.

• The expense ratios for the GLD (SPDR Gold Shares ETF) and IAU (iShares Gold Trust) ETFs are reasonable proxies for storage expense, at 40/25 basis points respectively.

• That puts the average gold holding cost at 33 bp, not far off German 10-year Bunds (-28 bp) and actually cheaper than all German sovereign debt with maturities less than 10 years (-37 to -77 bp).

Takeaway: It is actually cheaper to store capital in gold than in some liquid financial assets just now. Yes, there is capital risk. But remember that gold has been relatively stable over recent memory, so buyers may well feel that this is a risk worth taking.

#2: … And so does market sentiment that the Federal Reserve will be cutting interest rates, causing a further decline in the value of the dollar:

• Gold, like oil, is largely priced in dollars across all major global end markets. A strong dollar hurts its affordability, whether you are talking Indian wedding gifts (an important source of demand) or buyers’ interest from Greater China.

• Measured by the DXY Index the dollar dropped by 1.5% last week, its largest 5-day decline of the year. Still, it would take a further drop of 2.3% just to take it to 1-year low levels.

Takeaway: currency and gold markets were late to the party in terms of expecting a more dovish Fed but are now making up for lost time. Fed Funds Futures markets were, as we have repeatedly highlighted in these notes, first in the door and now other capital markets (stocks included) are catching up.

#3: As far as near-term sources of gold demand, the Q1 World Gold Council Demand Trends report shows one interesting buyer:

• Global gold demand grew by 7% in Q1 2019 against an easy comp. Q1 2018 demand was at a 3-year low.

• Central bank buying was the largest source of “surprise” demand, up 146 tons and the largest add for any Q1 back to 2013 when it comes to this sort of buyer.

• ETF demand was also good, up 49% year-over-year, but industrial demand (mostly from the Tech industry) hit a 2-year low. There is an average of 0.034 grams of gold in every cell phone, by the way…

• Gold supply, both newly mined and recycled, was flat in Q1.

Takeaway: global central banks – think Russia and Turkey – have been the marginal buyer for gold not just in Q1 but last year as well. That they bought more in Q1 than usual for this period indicates they are not likely done with their purchases. The “barbarous relic” may not be a part of how western central banks consider policy, but it still clearly plays a role elsewhere.

Summing up: gold is getting a lot of buzz just now and it’s easy enough to see why. Buoyed by lower global rates and continued central bank buying, the runway looks clear. From an investment standpoint, we’re in the camp that says a 3-5% weighting in gold is prudent. But unlike the last 5 years, such a position should now actually earn its keep.

Sources:
World Gold Council report: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q1-2019

DAILY DISRUPTION FEATURE

Ten days ago US Senator Marco Rubio sent a letter to the Chair/CEO of MSCI, the global index provider, questioning the inclusion/increased weighting of Chinese “A-share” companies in the MSCI Emerging Markets Index. His points:

• Since the index is available to US investors (through popular ETF products like iShares’ EEM, for example), American policymakers/regulators have responsibility for ensuring that its holdings meet basic disclosure and reporting requirements.

• Chinese A-shares in particular are a pretty opaque group of companies, and Rubio’s letter says “MSCI acknowledges that 58% of the constituents in the A-shares Index are controlled by the Chinese state.”

• Rubio asks MSCI if they performed enough due diligence to know who holds the debt/equity of these companies and if the Chinese government could assert influence or control over them. He also asks if MSCI’s research extended to ascertaining if these companies are military contractors, enabling the Chinese government crackdown of the local Uygher population, or engaged in cyber espionage among other questions.

This initial salvo went largely unnoticed, but the South China Morning Post ran a story about it over the weekend after speaking directly with Senator Rubio. There’s a link in the section below, but when asked essentially “why do this now?” his reply was that President Trump’s China trade policy makes MSCI’s decision to increase A-share weightings highly problematic. Why would the US open its capital markets even further to a country it feels doesn’t work within international norms?

As much as this may look like a political stunt ahead of the upcoming Trump/Xi trade meeting at the end of the week, we wouldn’t entirely dismiss it. Here’s why:

• Even with the chill caused by the US-China trade dispute, Chinese companies do clearly benefit from access to American capital markets. While China IPOs are down dramatically versus last year, Luckin Coffee recently raised $560 million in a NASDAQ IPO, for example.

• When viewed through an ESG (environmental, social, and governance) lens, Rubio actually makes a very fair point. MSCI’s decision to up the “inclusion factor” for Chinese A-shares from 5% to 20% in three stages this year makes the Emerging Markets Index harder to evaluate on an ESG basis. All the recent analysis of Huawei’s possible ties to the Chinese Communist Party has highlighted just how little outsiders know about even some of China’s largest and most globally important companies.

• Thanks in part to changes in Hong Kong Stock Exchange listing requirements, Alibaba is reportedly pursuing a capital raise/listing there later this year. Right now, it is only listed in the US but it certainly makes sense for the company to trade in a market where retail investors may also be customers. And it’s a good hedge against further changes in US policy with respect to Chinese access to American capital markets.

Bottom line: We’re surprised it took this long for Washington to figure out that the Chinese economy benefits from access to US capital markets. Big tariffs on goods but no restrictions on capital investment seemed odd. It is telling that the first shot came from a critique of MSCI, an index provider, rather than jawboning about individual company listings. One more sign, it seems, that indexes are what gets attention now. Not stocks.

Sources:
Rubio’s letter to MSCI: https://www.rubio.senate.gov/public/index.cfm/press-releases?ContentRecord_id=C8851CBD-9AA2-45BC-85D3-619647A64D75

TODAY'S MARKET RECAP

US equities reached record highs on Friday, but ended slightly lower. Large caps bested small caps: S&P 500 (-0.13%) vs. Russell 2000 (-0.89%).

Energy (+0.82%) and utilities (+0.47%) outperformed the broader market indices, while real estate (-1.10%) and industrials (-0.51%) lagged. Disney (-1.26%) and Dow Inc (-1.16%) weighed on the Dow (-0.13%); UnitedHealth (+1.82%) and Exxon Mobil (+1.41%) were the index's best performers.

The Nasdaq edged down 0.24%, while tech lost 0.47%. The "FAANG" stocks were mixed: Facebook (+0.85%), Amazon (-0.36%), Apple (-0.34%), Netflix (+1.10%), Alphabet (+0.94%).

The VIX gained 4.41% to 15.40. The 30-year and 10-year Treasury yields increased to 2.586% and 2.059% respectively, while the 2-year yield rose to 1.772%. The difference between 2-Year and 10-Year Treasuries is at 29 basis points. History shows that once the Treasury yield curve inverts (10s yield less than 2s) a US recession is likely.

If you missed today's market action, here is a useful summary by CNBC.

TODAY'S CURATED LINKS

Must Read of the Day: "Vice President Pence will delay a speech detailing the administration's policies toward China until after the Group of 20 (G-20) summit, an administration official confirmed Friday. Pence was scheduled to deliver remarks on Monday elaborating on actions the U.S. would like to see China take. Instead, the vice president will hold off amid signs of progress before President Trump and Chinese President Xi Jinping meet at next weekend's summit in Osaka, Japan." Source: The Hill

"US Senator Marco Rubio is using the trade impasse between Washington and Beijing to open a new front of potential friction between the two nations, by questioning why a major player in global stock benchmarks is including Chinese shares in its stock indexes – years after that process has been under way. In a June 12 letter to Henry Fernandez, the chairman and chief executive officer of MSCI, Rubio questioned why the China A-shares class of stock, which trade in mainland China and typically are only available to mainland Chinese citizens, are being included in the company’s global indices, which overall serve as benchmarks to US$14.8 trillion in equity assets." Source: SCMP

"President Trump approved an offensive cyberstrike that disabled Iranian computer systems used to control rocket and missile launches, even as he backed away from a conventional military attack in response to its downing Thursday of an unmanned U.S. surveillance drone... The cyberstrikes, launched Thursday night by personnel with U.S. Cyber Command, were in the works for weeks if not months, according to two of these people, who said the Pentagon proposed launching them after Iran’s alleged attacks on two oil tankers in the Gulf of Oman earlier this month." Source: The Washington Post

"The U.S. Commerce Department has banned five more Chinese entities from buying U.S. components after blacklisting telecom giant Huawei last month. Higon, Chengdu Haiguang Integrated Circuit, Chengdu Haiguang Microelectronics Technology, Sugon and Wuxi Jiangnan Institute of Computing Technology are the five Chinese firms added to the department’s entity list, according to a filing. The department said the activities of these companies 'pose a significant risk of being or becoming involved in activities contrary to the national security and foreign policy interests of the United States'.” Source: CNBC

"At a recent event hosted for founders by the venture firm Village Global, one of its most prominent investors, Bill Gates, sat down with Eventbrite cofounder and CEO Julia Hartz to discuss founding a company and the tough decisions necessary at nearly every turn in order to create and sustain a thriving enterprise... Gates is still kicking himself for taking his eyes off the ball and allowing Google to develop Android, the 'standard non-Apple phone form platform,' as he describes it. 'That was a natural thing for Microsoft to win'.” Source: TechCrunch

"President Donald Trump said he never threatened to demote Federal Reserve Chairman Jerome Powell, though he maintained he has the authority to do so. 'I didn’t ever threaten to demote him,' Trump said in an interview with NBC’s 'Meet The Press' that broadcasted Sunday. 'I’d be able to do that if I wanted, but I haven’t suggested that.' 'I have the right to do that, but I haven’t said that,' the president continued. Trump went on to criticize the Federal Reserve for raising interest rates, saying Chairman Powell made a mistake." Source: CNBC

"China’s largest ride-hailing player, has opened its platform to rival companies allowing users to hail a car from third-party service providers as the battle to build the biggest and best super mobility app in the country heats up. The Beijing-based company’s moves comes as rivals Meituan Dianping and AutoNavi, both of which already offer one-stop spontaneous ride-hailing services from multiple dispatchers, continue to expand their operations." Source: SCMP

"With its acceleration of Prime shipping from two days to one, Amazon established a new normal. Soon after, Walmart and Target came out with their own super-speedy shipping options. Why it matters: Flying, trucking and delivering millions of packages a day comes with a cost — as shoppers demand faster and faster speed, there has been a sharp environmental impact. The big picture: Consumers have gotten hooked on speed — and the efficiencies that e-commerce injected into retail are getting erased because now there are more deliveries of smaller numbers of packages." Source: Axios

MIND CANDY

The new AR game Harry Potter: Wizards Unite came out on Thursday and was installed +400,000 times in its first 24 hours in the US and UK. That translated into about $300,000 in gross player spending across iOS and Android. It has not been as big a hit as Pokémon GO, however, which grossed $1.6 million in those two markets over that time frame. Still it's expected to reach $100 million in consumer spend in its first 30 days, which Pokémon GO earned in two weeks.

Source: TechCrunch

Spread the word!

For every person you refer to subscribe to our DataTrek Morning Briefings, we will give you and our new paying customer a $50 Amazon gift card each as a token of our gratitude.

**Just email jessica@datatrekresearch.com the name and email of your referral after they subscribe and we'll send you both a gift card asap. As always, thank you for your support!

**New readers can get a 2-week (no credit-card) free trial at datatrekresearch.com.

Questions or Comments? Reach us at: info@datatrekresearch.com
Visit our website at: datatrekresearch.com

DataTrek Research, LLC (“DataTrek”) is making the material, data and information (collectively “DataTrek Information”) contained in this email newsletter (this “Newsletter”) available to its subscribers for informational purposes only. The DataTrek Information is not intended to provide tax, legal or investment advice, and does not constitute a suggestion, solicitation or offer to purchase or sell securities. DataTrek believes that the DataTrek Information is reliable, but does not warrant its completeness or accuracy. DataTrek assumes no duty to update such information. Subscribers should carefully read the DataTrek Terms of Service, Privacy Policy and Subscription Agreement, including accompanying documentation, as those documents contain important information and disclosures about the products or services covered thereby. These documents are available at http://datatrekresearch.com/terms-of-service-for-datatrek-research-services/, http://datatrekresearch.com/subscription-agreement-eula/, and http://datatrekresearch.com/datatrek-research-privacy-policy. DataTrek Information is subject to change at any time. DataTrek is not responsible for third-party information or services, including market data from any securities exchange.

Unsubscribe

DataTrek Research 350 West 57th Street New York, New York 10019 United States