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.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
