Head of Equity Strategy
Summary: In today's equity update we talk about the disappointing Q2 results from HSBC and Societe Generale confirming the depressing outlook for banks as the industry fights multiple headwinds from too high costs, low yields, flat yield curve and deteriorating credit quality due to COVID-19. We also talk about the good earnings from the big US technology companies last week and how it cements the path towards higher gains in equities and especially technology stocks. Finally, we take a look at Microsoft's attempt to acquire TikTok in four countries and how it could become a key acquisition for the future of Microsoft.
HSBC and Societe Generale have reported Q2 earnings today shaking investor confidence once again in banks as profits are surprising to the downside with HSBC forecasting loan losses to hit $13bn due the COVID-19 pandemic. HSBC is experiencing headwinds from a slower economy, increasing loan losses predominately among its commercial customers and then a low and flat yield curve. Societe Generale has all the same issues topped up with a faltering trading business leading to a surprise net income €1.3bn loss in Q2.
Negative on banks as low profitability is “locked” by governments
As result, European banks are down 1% in today’s sessions and are hitting fresh lows not seen since 2009. The STOXX 600 Banks total return index is down 57% since its inception in 2001 and is only up 19% since the lows in 2009. Central banks and private commercial banks are essentially an extension of the government and commercial banks have generally over the past 100 years been a profitable enterprise, but with recent central bank policy and increasing regulation the private commercial banking industry has slipped into “utility state” with very low profitability and limited growth potential. The COVID-19 has caused many governments to issue loan guarantees to ensure banks are continuing to extend credit moving the industry even closer to a quasi-government run credit operation. Overall, it is hard to be optimistic on banks, and even US banks, and our view is to be underweight banks across all regions.
Tech earnings surprised paving the way for more gains
Last week saw earnings from all the major US technology companies and they were all strong relative to the weak backdrop of overall economic activity bolstering confidence among investors in their bets on technology stocks. Especially, Facebook and Google showed robust advertising revenue highlighting the fact that even in a struggling economy the technology giants can increase revenue as activity is still being pushed online. This characteristic will continue to push up market valuation on technology companies and with the US 10-year yield at 0.54% investors will accept the high valuations.
The thing with growth stocks in a low yield environment is that you are willing to pay a very high valuation because of the alternative and growth compounding. Imagine a growth technology company growing 15% a year with a valuation of 2% free cash flow yield. The yield itself is low but still four times higher than what is offered in risk-free bonds. The investor buying the shares at this high valuation could easily absorb a growth slowdown to 7.5% per year and a 30% increase in the free cash flow yield and still have a much more attractive expected return over the long-term. That is in a nutshell the new paradigm we are in – at current yields almost everything goes in equities except for low growth value stocks.
Microsoft golden moment to enter internet media
We have been arguing for years as the US-China trade war raged on that the conflict was evolving into a new “cold war” and that it was basically a fight over technology which naturally would lead to two “systems” on the Internet. With the Trump administration’s recent ban on TikTok in the US its parent company ByteDance has been scrambling to save its US business. ByteDance has argued for a spin-off into a separate entity but that would still allow operational ties back to its Chinese entity, something the US security intelligence apparatus would argue against. Microsoft is brokering a deal to acquire TikTok’s business in the US, Canada, Australia and New Zealand and is aiming to complete the deal before September 15. According to a Reuters report, ByteDance believes TikTok is worth $50bn and thus the Microsoft deal to acquire the business in four countries would most likely be a sizeable share of this value; the US business has alone 100mn users. Microsoft has in recent years acquired assets outside its core operating system and cloud business via acquisitions of Minecraft and LinkedIn. In our view this could be an essential deal to Microsoft as the company clearly lacks a stronghold in social media and internet media, and the TikTok business would propel into a size where it is a threat to Facebook and Google. Facebook’s acquisition of Instagram was immediately touted as too expensive but has in hindsight been heralded as a genius stroke by Facebook. Likewise, Microsoft’s potential acquisition of TikTok could become a game changer for the company and it needs a stronghold in internet media as this category will become even bigger in the future.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
