Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Equities are holding the line after FOMC
Peter Garnry
Chief Investment Strategist
Summary: Despite the FOMC volatility, USD repo market stress and macro numbers still mixed US equities are managing to hold the line close to all-time highs. In India sentiment got help from the government lowering the corporate tax rate. In today's equity update we also talk about valuation on software companies and earnings next week from Nike and Micron Technology.
The FOMC smelled of missed opportunity for the Fed to get ahead of the curve and the complacency on the US-China trade war and recently ongoing stress in the USD repo market. Despite this backdrop US equities are close to all-time highs as we leave this central bank week and preparing for next week which will be very exciting on the macro release front. Most notably the Eurozone and US flash PMIs on Monday will move the market and for rates traders the US PCE inflation (Aug) figure on Friday will be an important data point.
We suspect next week to be a tug of war between the bulls and bears in equities. If the S&P 500 futures manage to climb to new all-time highs, then we expect shorts to vanish like water in the Sahara. This will clear the path for higher equities despite the muddy macro picture. While remain negative on macro we cannot ignore the technical price action.
As we have said on our daily Market Call podcast India is a train wreck with credit worsening and consumer confidence measured by new car registrations plummeting. However, today news broke that the Indian government is stimulating the economy through cutting the corporate taxes for new domestic companies. The Nifty 50 Index was up 4% breaking above the recent trading range but in the greater picture (see chart) the technical picture looks ugly. As long as the global economy is slowing down and the USD remains strong India is an equity market investors should underweight.
While US equities are flirting with record highs it is worth noting that the second largest industry group Software & Services is now valued in the 99% percentile on EV/EBITDA; not a good recipe for future returns. We often just talk about valuations as something abstract but the one as to realize that EV/EBITDA just above 20x means that an implied return expectation by investors of around 4.8%. Is that really a fair hurdle rate to expect for your capital given where we are in the business cycle? Our view is that valuations on software companies have reached unsustainable levels given the outlook and the risk-reward ratio is just terrible.
While the Q3 calendar period is not over yet some companies, that are not following the strict calendar year, are still reporting earnings. Nike reports FY20 Q1 earnings on Tuesday with analysts expecting EPS of $0.701 up from $0.67 a year ago. Analysts expect revenue to continue growing by high-single-digit driven by expansion in its woman’s business and e-commerce. Nike’s margins have lately been under pressure so there will be a great focus on this issue from analysts on the conference call. Nike’s valuation on EV/EBITDA is 24.9x which is a steep premium to the S&P 500 ratio of 13.4x.
From a macro point of view the FY19 Q4 earnings release from Micron Technology is of importance as the memory manufacturer sits in the middle of the global economic slowdown and escalating trade war. Analysts expect Micron Technology to deliver EPS of $0.478 down from $3.53 a whopping decline of 86.5%. Analysts are split on the company’s outlook with the current price at the current consensus price target.
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