Daily Agenda: Bears and Bulls Argue Over Equity Valuation
Asian Development Bank convenes; Russia pledges funding for BRICS lead fund to rival the IMF; earnings season continues.
With the Federal Reserve looking toward tightening, a recurring theme in investor sentiment is how much leverage will remain within U.S. financial markets and among equity investors specifically, how much of the rapid flow of credit accounts for the present bull market. Financial data firm Dealogic estimates that $610 billion in corporate debt has been issued by U.S. companies year-to-date versus $570 billion during the same period in 2014 as borrowers rush to lock in low interest rates by feeding bond market demand for some measure of yield over Treasuries. Meanwhile, U.S. companies rushing to take advantage of the low cost of borrowing in Europe due to European Central Bank easing actions is also picking up with U.S. issuance in the euro zone on track to exceed the $92 billion hit last year. Bearish analysts continue to warn that U.S. equities, which have continue to achieve new record highs in recent weeks, are rising largely on the back of deals and buybacks that are driven by low borrowing costs. Not everyone agrees, however. In a note to investors last week, David Rosenberg, chief market strategist at Toronto wealth management firm Gluskin Sheff + Associates, noted that what the U.S. economy has lacked in vigor during the recovery period it has in the expansion’s staying power. “At no time in recorded history has the U.S. economy been this far into recovery with this much capacity to grow without the economy bumping against restraints and forcing the Fed into aggressive rates action,” he writes, adding “maybe, just maybe, this sort of no boom-no bust cycle deserves to have a premium multiple.”
PMI in China falls further. Final Chinese HSBC manufacturing purchasing manager index levels for April registered lower than the already disappointing flash level at 48.9 and well below consensus estimates. This sits in stark contrast to marginal improvement in official national Bureau of Statistics data released last week. Critically, the new orders subindex contracted to 48.7 in the sharpest drop in 12 months. The HSBC survey set covers small and midsize industrial companies whereas the official figure is derived from major firms, suggesting that recovery among smaller manufacturers is lagging.
Mixed European PMI data. The final April reading for Markit manufacturing PMI indicated that German factories continue to expand, albeit at a slower pace than initial flash estimates indicated, while France registered a 12th consecutive contraction. Aggregate euro zone manufacturing levels, at 52, show industrial activity continuing to expand in the combined currency region.
Asian Development Bank meets in Baku. The 48th annual meeting of the Asian Development Bank kicked off in Baku, Azerbaijan over the weekend. A trilateral meeting between policy leaders from China, Japan and South Korea headed by Japanese Finance minister Taro Aso took place during the first day of the event to issue a joint statement, warning of potential volatility in capital flows as the U.S. Federal Reserve begins tightening in the coming months.
Russia ratifies CRA. Over the weekend Russian President Vladimir Putin ratified the Contingent Reserve Arrangement, a monetary fund established by Brazil, Russia, India, China and South Africa at the Fortaleza summit in July 2014, after funding was approved by Russia’s upper house of parliament. The fund, which will consist of the $41 billion already pledged by China, $5 billion from South Africa and $18 billion from the remaining members, is intended as a reserve fund to rival the International Monetary Fund. The so-called BRICS also agreed at Fortaleza to create an as of yet unfunded Shanghai–based lender dubbed the New Development Bank.
U.S. earnings season continues. On a busy day for earnings releases, the U.S. cable industry comes into focus with quarterly results from Comcast and Cablevision Systems. Comcast, which recently walked away from a proposed merger with Time Warner Cable, posted stronger-than-anticipated profits for the first three months of the year on the back of solid revenues in the company’s broadband division. Cablevision Systems announced adjusted earnings of $0.20 per share, well ahead of analyst estimates although, significantly lower than during the same period in 2014. Anadarko Petroleum Corp. will announce first-quarter results after equity markets close in New York today. The exploration and production company’s results will be carefully watched by investors gauging the long-term impact of lower oil prices on pure plays in the sector.
Fosun expands insurance reach with Ironshore acquisition. Fosun International, an investment vehicle controlled by Chinese billionaire Guo Guangchang’s steel company Fosun Group, announced plans to acquire the remaining stake not already owned in Ironshore Inc. for $1.8 billion. Bermuda–based insurer Ironshore was created by AIG executives in 2006.
Portfolio Perspective: The Credit Boom — Brian Reynolds, Rosenblatt Securities
When GE announced its $50 billion buyback in early April, the stock surged and filled that gap from April 2008. Investors then promptly sold it. When Apple announced its $50 billion buyback, the stock hit a new high of $134.50. As with GE, that surge was promptly met with selling, knocking the price down to $125.
During a credit boom, such periods of flat stock prices from investor selling are usually met with even more financial engineering from CEOs, financed by credit investors. We believe this is likely to happen this year, as it appears that the credit boom is primed to intensify yet again. Our nation’s public pensions are taking more money than ever and are investing it more aggressively than ever. We’ve now discovered more than 595 pension votes to put more money into credit in the 32 months we’ve been doing this exercise. That’s about 19 per month.
We note that these listings of credit votes don’t include any leverage that may be applied, and don’t cover any additional allocations to existing managers from cash flows, which are often not publicly announced. Also, many real estate and private equity funds either utilize and/or buy debt and a disproportionate amount of these credit flows continue to target the real estate sector. In the summer of 2013, we concluded that commercial real estate was a likely candidate for the next bubble, now that the commodity bubble is winding down. These votes support that conclusion.
We know that equity investors dislike stocks, and that they have a hard time buying stocks at new highs. But, these continued credit votes reinforce our belief that not only will any pullbacks be brief and shallow, but that debt-fueled financial engineering should continue to take stock prices higher over time, to the surprise of most equity investors, as CEOs have no problem whatsoever buying stocks at all-time highs.
Brian Reynolds is the chief market strategist for Rosenblatt Securities in New York.