4 July 2018
Global equities continue to be led by US tech companies
Global equities continue to be shown leadership by the US tech sector. Collectively, the market capitalization of the top 5 US tech companies (Facebook, Amazon, Apple, Microsoft and Alphabet’s Google) is worth more than the 50 largest stocks in the eurozone, while Apple is close to becoming the world’s first trillion dollar valued company. Though there are concerns about a bubble in US tech sector stocks, there are considerable differences compared to the valuations during the dot.com frenzy of 2000. The current, equal-weighted forward price-to-earnings (PE) multiple for the top 5 US tech companies is 25x, compared to 63x for the equivalent ranked stocks (Microsoft, Cisco Systems, Intel, Oracle and Sun Microsystems) at the time of the peak of the tech boom in March 2000. More fundamentally, and unlike 2000, the tech sector continues to be backstopped by strengthening tech demand. For example, real investment in US information technology products and software grew 8.2% from a year ago in Q1, the fastest rate in more than a decade. In contrast, following years of disappointing price performance, General Electric (GE) was removed from the Dow Jones Industrials (DJI) stock index. GE was the last original member from the DJI, formed in 1896, and its exit from this benchmark mirrors the shift in the US towards tech as a source of growth over older industries.
Not quite “Arrivederci Roma”
Over in the eurozone, and after five months of deadlock, Italy formed a new government around the anti-establishment and anti-EU Five Star Movement and Lega parties. Uncertainty in the policies of the new administration, including the possibility that Italy leaves the euro, initially sparked volatility in Italian equity and bond prices. However, in his first interview as finance minister, Professor Giovanni Tria, calmed market nerves by stating that Italy remains committed to the single-currency. Moreover, Professor Tria made clear that Rome is committed to reducing the public debt and deficit and will not threaten its European partners in upcoming discussions on fiscal targets. Despite these reassuring comments from the finance minister, the bank-exposed eurozone bourses have underperformed global stocks this year, partly due to concerns over rising interest rates in Italy and the slow pace of dealing with bad debts on bank balance sheets. It is worth noting that JPMorgan of the US is now worth 15 times more than Germany’s Deutsche Bank. Around twenty years ago Deutsche Bank was larger than JPM. These comparisons reflect the fact that American banks were quicker to recapitalise and shore-up balance sheets than their European counterparts.
Risks in Emerging Markets and trade protectionism
Emerging Market (EM) risk assets (equities, bonds and currencies) have come under selling pressure over the past few months. Part of the reason lies with the renewed strength in the US dollar, which raises concerns about how these counties will service their USD-denominated debt. The most vulnerable developing economies have been Argentina and Turkey, which have seen their currencies fall sharply year-to-date.
However, it could be argued that financial contagion spreading to the EM complex is limited. First, Argentina and Turkey have been overheating for some time, as evidenced through higher inflation and widening current account deficits, and are an idiosyncratic risk, as against a systemic risk to the EM complex. Second, double-digit forward Earnings Per Share growth in EMs provides an anchor of support to investors. Third, Asian markets are supported by the historic meeting between US President Trump and North Korea’s Kim Jong-un in Singapore last month. Although the meeting lacked specific targets in the denuclearisation of North Korea, greater communication by the leadership of the US and North Korea should ease regional geopolitical risk. And finally, stability of the Chinese economy adds another line of support.
However, the step-up in trade protectionism by President Trump is concerning for markets. In June, the Trump Administration said it will apply 25% tariffs on $34bn of Chinese goods from 6 July. Beijing said it would respond with tariffs on US exports to China. The Chinese government could even target US firms operating in the country through consumer boycotts or increased regulatory checks. This could potentially hit US company profits. Another tail-risk for markets to watch out for would be a devaluation in the renminbi, given the sensitivity shown by markets in the summer of 2015 to the weakness of the Chinese currency back then. For the moment, this looks unlikely, as Chinese exports are still growing strongly and it would go against Chinese President Xi’s reform agenda to use the market to allocate financial resources.
Nevertheless, following the correction in EM equities, valuations look more attractive at these levels. We continue to look for strategic opportunities in Far East markets, where we view risks as more balanced with improving underlying fundamentals.