Eye on the Markets - 2019


Equities Improve, Near-Term Recession Fear Quelled

By Ketu Desai

Equity markets bounced back in September, as the tone around the trade war improved and central banks continued to provide support to the market. Central banks appear to have provided a floor for the equity markets, however, the markets remain stuck in a range. During the month, the ECB cut rates and restarted quantitative easing, the Chinese cut their reserve requirement ratio, and India surprisingly cut corporate tax rates. Domestically, the Fed cut rates again, monetary support combined with lower taxes and a record federal deficit provide meaningful stimulus to the economy. There are early indications that stimulus is hitting the economy. The Citigroup Economic Surprise index has popped in recent weeks, indicating economic data is beating estimates.

If nothing else, the latest economic data has quelled near-term recession fear. Consumer data continues to be strong with initial jobless claims near all-time lows, solid wage growth, and strong earnings from retailers such as Walmart, Target, and Nike. While recent manufacturing data has come in better than expected with an improvement in PMIs, and strong earnings and increased guidance from companies such as Cintas, it still remains weak. Overall, the domestic economy remains on pace for approximately 2 percent growth, with the trade war putting a lid on both economic growth and the market.

With the economic data coming in better than expected, rates moved up, and a number of sector and factor rotations have taken place. Investors rotated out of bond-proxy sectors such as utilities into financials, which benefit from higher rates. JP Morgan hit an all-time high during the month. Investors rotated out of expensive secular growth stocks into value cyclical growth stocks. Particularly, we saw investors sell secular theme names in payments, fintech, software, and cloud for semiconductors and industrials. The semiconductor ETF nearly hit an all-time high during the month. We even saw signs of life this month from small caps and EM. The barbell portfolio that has worked over the past year of long bond and bond-proxies with secular growth equities, started to underperform this month. Whether this month marked a turning point for such approach is to be seen. I think a lot will depend on whether the economic data continues to improve and moderation in the trade war.

In the past twenty years, private markets have boomed, growing more than 5x, while the number of listed public companies have been approximately cut in half. This is partly due to regulation such as the 1996 National Securities Markets Improvement Act and the 2012 JOBS Act (which increased the allowed number of investors in large private firms from 500 to 2,000) that made it easier for wealthy people and institutions to invest in private equity. The growth of the private market has led to companies staying private longer, larger funds raised such as Softbank's $100 billion Vision Fund, and higher valuations. In 2019, many of these private companies have come public, often without earnings and high valuations. For instance, names such as Zoom, Slack, Cloudflare, and CrowdStrike have come public at 47x, 45x, 25x, and 41x sales! In recent weeks, sparked by the significant cut to WeWork's valuation, many of these names are down quite significantly. I think the recent action highlights the froth in the late-stage private markets and that earnings and valuation matter. For public market investors, I think this is positive, as investors are punishing froth and overvaluation. Further, it has the potential to delay other large companies from coming public, as we saw with WeWork and Endeavor, thus reducing supply in public markets.

Looking forward, the market will focus on third quarter earnings, and pay close attention to a planned meeting among senior trade officials.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com