Head of Equity Strategy
Summary: In today's equity update we talk about yesterday's explosion in key USD funding indices indicating that there is a shortage of USD liquidity in the system. This is typically a sign of stress and short not be taken easy. On top of this Aramco has revised down their expectations for how fast they can get oil production back to previous levels adding pressure on global oil prices which is not what the world economy needs amid a slowdown. If the FOMC does not deliver some magic tomorrow we believe equities will begin rolling over.
If we told you that equities would be flat yesterday in US session on the backdrop of weaker than expected Chinese macro, the biggest oil shock since the early 1990s and a galloping USD funding crisis, you have rolled your eyes. But that’s the market as of yesterday. Equities are a bit risk-off this morning, but all equity markets look like they are rolling over, so unless FOMC tomorrow delivers some magic on the guidance then traders should shift into short positions on equities.
USD funding crisis is serious
The talk of town yesterday was the apparent spike in the FRA-OIS spread which is essentially the spread on LIBOR-Fed Effective Rate swap. If this spread rises the is a USD funding issue and creditworthiness among banks is deteriorating. In addition to the blowout in the FRA-OIS spread the general collateral repo rate in the US funding market also spiked yesterday sending worrying signals to the market that the Fed might be losing control over policy rates. If the FOMC is not openly talking about these events and downplaying the current situation then it’s risk-off tomorrow across the board as it will be a policy mistake on par with the December 2018 decision to hike.
Emerging market equities are obviously feeling the heat the most from stronger USD and higher oil price which are squeezing emerging market consumers and government finances in local currency. The weaker than expected Chinese macro data yesterday also support downward trajectory in emerging market equities.
Why did the oil shock not move equities more?
We are getting a lot of questions why the oil shock has not moved the overall equity market more. While the energy market is important for the world it’s no longer that important for market value as the energy sector is only 5% of the global equity market. Global equity markets are driven by financials and technology companies which profits are quite insensitive to energy prices, at least at current levels. In addition, the capital expenditures among energy companies are still down 50% from the peak in 2014 so the jump in oil price will not feed through to real investments anytime soon.
However, the latest news from Aramco is that it could take weeks and months to restore oil production back to where it was before the attack. We see the pain point for Brent Crude into the equity market at around the $80/brl level so there is still some margin of safety. The real threat to global equities comes from geopolitical risks on the rise with both Saudi Arabia and the US pointing at Iran as the culprit of the weekend’s oil attack.
Stocks to watch
Sentiment on Apple shares is in short-term a struggle between better than expected demand for the new iPhone 11, especially in the Chinese market where Apple has struggled, and a potential $14.4bn tax bill issued by the European Union. On the margin Apple’s news flow is positive and the uptake in iPhone 11 demand is more important than a potential tax bill in the EU only 25% of the last 12-month free cash flow. Investors are agreeing to this view with the share price up 57% since early January when Apple cut its guidance on a weak Chinese market. However, Apple is not paying the $14.4bn tax bill levied on the company in 2016 by the EU Competition Commissioner Margrethe Vestager without an EU court fight which takes place this week. If the EU court decides that Apple’s tax deal with Ireland was illegal it could permanently squeeze Apple’s profit margin as profits in the EU would be taxes at a higher tax rate going forward.
We Company, the former WeWork, is said to have postponed its IPO following significant negative news flow around its CEO and founder, and its lack of good corporate governance. Not even lowering the valuation to around $10, which is far less than the previous private round valuing the company at $47bn, was enough to spur interest from investors. We do not think We Company will come back successfully to public markets as the public relations damage has already happened and will most likely haunt the company for years. We Company is just one more recent Silicon Valley IPO which is valued at too high valuation levels and come with usual Silicon Valley dual share class system. We sense that the Silicon Valley reputation has taken a massive hit over the past two years and the perception is changing around technology companies.