Equity Monthly: It begins and ends with China

As we have said before, summer 2019 looks increasingly to be the time when the economy could worsen and see higher volatility in financial markets. In 2019, the Federal Reserve’s monetary tightening will peak at exact the same time the fiscal impulse runs out. The structurally high deficit in the US will likely push interest rates higher, increasing the global price of money which will begin unwinding certain capital structures.

The amount of activities that have been funded by this low interest rate environment through the high yield market is incredible and will eventually be unwound (as they are not productive under higher interest rates).

Stay defensive

Although our Stronghold dynamic asset allocation portfolio added a bit more risk this week it is mostly insignificant and a technicality. Overall the portfolio is still balanced, tilted to towards being mildly defensive. This is also our overall stance on equities. The scenario described above means that emerging markets, China and everything cyclical should be underweight. Investors should focus on low volatility and high quality stocks as these should historically do better in a more uncertain world.

What could make us change our stance? Three things:

1. The Fed slows down the interest rate cycle 
2. China manages to steer the economy out of its current downturn
3. Trade war escalation never happens

Technology is not a sell

On Monday we looked into technology stocks post the Facebook Q2 earnings shocker that had ripple effects in all technology stocks. Netflix and Twitter have also disappointed this earnings season and it’s a fair question to ask whether the wheels are coming off tech shares. In yesterday’s morning call we showed the table below arguing that technology stocks trade at a little premium to global equities given the substantially higher growth rates and unique business models generating high return on capital.

Obviously there are pockets of overvaluation in technology, like in all sectors, but the overall picture is not negative. Selective stories and valuation cases look dangerous but getting exposure to technology growth is still a sensible strategy – even in a slowing global growth scenario. More importantly, technology stocks have in general very little interest rate sensitivity due to their negative net debt position which makes them interesting in a rising interest rate environment.

The stocks highlighted below should not be viewed as trade recommendations. These stocks are selected for valuation comparisons only.