Creatures of the Night
The air inside was warm this morning. Too warm. Too early. Most normal folk would still call it night. I opened the window. A gust of wind blew paperwork all over my office. I closed the window. I checked my numbers. The night had seemed to pass uneventfully. About 45 minutes later, one shoe drops. The March Manufacturing PMI flash for France missed badly. Wow. Okay, futures markets seem to be taking that news okay. Fifteen minutes later it became apparent that Europe has a bigger problem than we even thought they had. To say that for March, Germany's Manufacturing PMI flash simply missed already very low estimates does not do the disastrous report proper service. The print hit the tape at a paltry 44.7. This badly missed expectations that pointed toward a still contraction-ary 48, and even lower than the 47.6 February number. That means that the pace of contraction across the German manufacturing sector is increasing... rapidly.
For Germany, this 44.7 number is a 79 month low for the series. That's more than six and a half years for those of you who still thank central bankers for their service. After peaking in late 2017 at 63.3 (remember synchronized global growth?), this series has experienced a print lower than the month prior in 14 of the last 15 months. In fact, employment across the sector actually decreased. European economists are blaming a number of factors this morning. Among the reasons would be Brexit, the U.S./China trade war, the global decline in the auto industry. Just not themselves. That would be silly. Blame whatever you want, but there is no recovery in manufacturing without new orders. There is no recovery in Germany without manufacturing. There is no recovery across Europe without Germany. Hence, global central banks have a problem, and the geo-political mix grows only more complicated.
Memorandum of Understanding
Some time later today (Friday), it is expected that Italy will break ranks with the G-7, break ranks with the EU, and break ranks with NATO to sign a Belt and Road Initiative (BRI) Memorandum of Understanding (with China). We spoke of this in Thursday's column. We spoke of a Cold War. Think this is not about strategic spheres of influence? Think that slowing global economic activity is not a significant force, placing pressure on leaders to find a way, any way to create potential where there was none prior? Keep thinking.
Chinese investment in Italy is currently tiny, nowhere near what has been seen over the past decade in the UK, Germany, Poland, France, or even Greece. Chinese construction in Switzerland over the past decade is easily twice that seen in Italy. Hence, the attraction. It does not require much imagination to see why a nation such as Italy, the Eurozone's third largest economy would seek to find its own way as significant players in the monetary union continue to weaken economically. It's also easy to see why China would want to make this overture, and easy to see this as generally negative from the point of view of the west. Understand that President Trump's fight with President Xi is much bigger than, and far more strategic than any trade deficit. Stay focused. A trade deal is only a sliver of what's at stake.
I will keep one item in the back of my head. Central banks are going to have to resort to the printing press earlier than anticipated. The percentage of global debt running at negative interest rates will increase. Fiscal policies will only grow sloppier. Nobody will be happy. The fastest way to spend newly created, borrowed money for sovereigns that also boosts employment in industrial production is in defense. Then the building/rebuilding of public infrastructure. Not only are they going to build stuff nobody really needs, but they're going to fight about it. The planet will become exponentially a more dangerous place, but hey... at least for a while, common folk will think that their leaders have saved their given economies. Oh joy. You know you need some gold, right?
The tug of war continues. Continues between economies overtly mired in broad decline, the near zero interest rate policy position that the central banks are forced into politically, and the onset period of TINA (There Is No Alternative) that forces higher multiples on equities.
How disgusting. How perverse really that professional economists could have thought that in mass coordination, they might have gotten away with skewing price discovery through intentionally fogging the ability to assess risk over time at the personal, corporate, national, and global levels. How arrogant. Go ahead. Worry about your NCAA bracket. I'll wait here.
I just can't. Even as I play the field, trying t run my game through balanced exposures to cash, physical assets, debt securities, and yes, my beloved equities... this seems to work. What does Doug Kass always say? Price changes sentiment... or something close to that. Well, Doug's right. The last sale, in our world tells you just how smart you are allowed to think you are. Still, even with a market trying to price in a yet unknown expansion in the current multiple from the now 16.3 times (which is also roughly the five year average), certain sectors will be impacted by other unrelated factors. I just can not own the banks with the yield curve this badly damaged.
Looking ahead toward first quarter earnings, the energy sector is expected to suffer significantly in terms of both profitability and revenue generation. Understand this. As crude pricing has improved in recent weeks, so has very likely energy sector performance. I am not going to be out that group of mostly high dividend paying free cash flow cows until they give me a reason. So far, that group has simply led my portfolio for four months. The financials are expected to post in aggregate, negative earnings growth on in-line revenue growth for the quarter. I do get that as the yield curve has put the banks in a bad spot, as the business of lending is not such a hot place to be, the industry has been able to create fee driven business lines in order to make some hay, not to mention trading these markets and the wonderful benefits of investment banking.
Still, the ability to generate net interest margin though natural means declines badly as yields not only flatten, but invert. On top of that, it hurts perception, which in turn impacts demand and supply in terms of order flow. This is why, even with the S&P 500 trading at 16.3 times forward looking earnings, that the financial sector trades at just 11.6 times. This is not only well below equities in general, but well below the sector's five year average of roughly 13 times. The banks are either cheap, or going nowhere. They've been cheap for a very long time. I'll hang onto my shares of JP Morgan (JPM) as best in class (my opinion), and I still have a small long position in KeyCorp (KEY) for the dividend, but honestly... I can not remember without looking it up, when it was that I last bought even a single share of a bank stock.
Zuora (ZUO) , my favorite stock, is trading lower overnight after reporting in line EPS on revenue that beat expectations for the fourth quarter. After the run-up leading into earnings, I had expected to see a bout of profit taking, which is why I told you that I sold some last week, and why I encouraged interested buyers to wait until after earnings to get involved.
CEO Tien Tzuo sounded great on the call. Am I biased by my long position and my public call? That's possible. There is no denying the inflection in delivery though that exuded confidence based on conviction. This is a regular kid from Brooklyn that knows what he is trying to do, and precisely how he is trying to do.
The one caveat I see is the change in the standard for forward guidance. Based on the old method, the numbers seem spot on. Based on the new method, they could be a little light. Either way, this selloff may just be opportunity knocking. I may not always be right, but I am in this foxhole with you and we are facing the same direction.
I have a call scheduled later today with Tzuo, so I should have more to say later. If too late for Friday publication, it will have to wait over the weekend. The markets a bit heavy now too, after those German numbers slapped futures markets around. I smell an options play in the making here.
The Big Apple. New York City? Not a chance. Try Cupertino, California. 10 am PT. Monday. This Monday. The Apple (AAPL) event has been named "It's Show Time." What it is will be the next major product launch event for the greatest consumer electronics company in history. We could probably leave out the words "consumer electronics" and that sentence would still ring true.
Thursday (yesterday). Needham, Citigroup. Wedbush Securities. There seemed to be a rush to increase target prices significantly ahead of this event. Take 'em. The shares closed on Thursday 3% higher than it's own 200 day SMA after having closed beneath that level every single night since mid-November. Wanna Rock? AAPL closed 15.4% above the stock's 50 day SMA (That's hard to do), and has not closed beneath that level since late January. Hard Charger. Next stop? Likely above 197. You may recall that this has been my target. I may just have to join the crowd and raise. I actually have skin in this game, so I will make a sale there first, then raise.
Expectations for Monday? Enhancements to the firm's service based ecosystem. I really can't wait to hear about this news subscription service, but for me the main event would be some kind of announcement around a new entertainment streaming service that will compete with Netflix (NFLX) , Walt Disney (DIS) , Hulu, AT&T (T) , and Amazon (AMZN) Prime. We all know that this field will only increase in competition, and that content owners will have some advantage in terms of margin. Does a dominant position in the hardware space offer an advantage in delivery of the service? Clearly if it is that content, and hardware matter more, then this will end being a two dog fight between Disney and Apple. Then again, I never count Amazon out. Ever. This we'll want to hear more on. The stock is still fundamentally cheaper than the broader equity market even after this recent run.
Economics (All Times Eastern):
09:45 - Markit Manufacturing PMI Flash (Mar): Expecting 53.5, Last 53.0.
09:45 - Markit Services PMI Flash (Mar): Expecting 56.3, Last 56.0.
10:00 - Existing Homes Sales (March-F): Expecting 5.1M, Last 4.94M SAAR..
10:00 - Wholesale Inventories (Jan-adv): Expecting 0.1% m/m, Last 1.1% m/m.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 833.
14:00 - Federal Budget Statement (Feb): Last $8.7B.
Today's Earnings Highlights (Consensus EPS Expectations):
Before the Open: (TIF) (1.60)
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