Chief Investment Strategist
It has been an impressive rebound in equities over the past week as markets quickly realized that the big selloff in Japanese equities and dramatic jump in the VIX Index were not warranted based on economic fundamentals. Japanese equities have almost fully recovered from the losses. We cannot rule out more volatility in Japan as Bank of Japan is forced to slowly hike its policy rate regardless of the implications for financial markets because its policies are creating big fragilities in the Japanese financial system and economy.
Starbucks shares are up 26% the past week as the global coffee and food chain announced Chipotle CEO Brian Niccol as its new CEO in a deal that is one of the most lucrative CEO deals in the US. Starbucks has had a flat to lower share price in the five year period before the new CEO announcement as the coffee chain has lost its former vibe among the consumer. The activist investor Elliott has been actively pushing the company to fix its problems and the big question is now whether the new CEO can turn things around.
Brian Niccol has delivered a formidable turnaround at Chipotle so the market is betting he can do the same. It will not be easy and the valuation metrics are not showing low expectations so immediate success might not be possible.
The earnings season is now in slow motion, but the recent week showed some interesting observations about US retailing. Home Depot, which is big ticket items or discretionary spending, disappointed investors with another guidance cut as the US consumer is holding back. The weakening demand for home improvements might be driven by consumer behaviour changes as the US consumer is waiting for lowering interest rates before deciding on bigger housing projects. Our guess is that there is a rather large pent-up demand waiting in the US discretionary retail sector as soon as interest rates begin to tick lower.
Walmart on the other hand was a strong earnings release as spending on necessities is still keeping pace with inflation. Walmart also raised its guidance and saw a narrower loss in its e-commerce business. Overall, US retail same-store sales is still looking robust in the Redbook time series with around 5% growth rate.
In Europe, strong earnings from Carlsberg and Pandora were the positive highlights whereas renewable energy stocks such as Vestas and Orsted disappointed yet again in a blow to the green transformation from an investor point of view.
UBS reported strong Q2 results and guided a return to profitability levels before the merger of Credit Suisse. We used the UBS results to sum the European banking earnings and outlook in our equity note European banks: Strong Q2 earnings as rate cuts loom. Our strategic view is that financials is one of the more interesting sectors from an expected return perspective and as long as interest rates remain at inflation levels plus a 1-1.5% spread then we get expect profitability to slowly improve. Zooming out to get the bigger picture we observe that European banks are still generally valued as industry below 1 on price-to-book which indicates that the industry is still not generating returns on equity surpassing its cost of capital.
European banks have traded at a discount to US banks for 10 years now and European banks have not been above 1 on price-to-book (which is the magical line for banking stocks) except for a few months in 2015. With the current economic backdrop, larger fiscal impulse coming in Europe from higher military spending and generally a higher central bank rate going forward, because of structural inflation dynamics, we expect European banks to continue recover some of their discount to US banks.
The week ahead: PMIs, initial jobless claims, and Palo Alto earnings
The big macro focus is on Thursday with PMI figures from the Eurozone and the US. The earnings season is less busy but Palo Alto Networks, the world’s largest cyber security company, will be the key watch on earnings, and especially after the recent CrowdStrike fallout.
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