Is DIVERSIFICATION the answer?

TESLA lost more than 10% of its stock price on 25^th January 2025, a day after it declared its quarterly results for Q4 2023. Poor financials driven by higher costs, competition and sluggish sales in international markets resulted in a thumbs down. 

This may have meant a 10% loss in portfolio value for someone who only held TESLA stock. For others, it could have been the loss of as little as a few hundred dollars depending on how much they had invested.

‘Do not put all your eggs in one basket’, as the cliched saying goes.

At best, diversification is a risk reduction mechanism. It allows us to spread our investments to minimize the impact of poor performance from one or more of the investments. 

On that theme, let’s say we invest into a family of hens and chickens to provide us with breakfast eggs. They do provide us the much needed, high quality breakfast……until one fine day when they catch a flu. If the flu virus then spread to the hen family, our investment would amount to 0. Might as well, have invested in a bank deposit alongside? Yes?

What kind of RISK? 

Risk can mean different things to different people. A drop of 2% value could be high risk for those with a low risk tolerance. Volatility can be extremely stressful to some investors, while others thrive on finding opportunities in volatile markets. 

Broadly, RISK refers to the possibility of losing money…….the risk of volatility and sudden losses; and the risk of compromising on returns or not being able to achieve our investment objectives.

A highly skewed, equity heavy portfolio may not give us the income we need and may lose value just at the wrong time. Similarly, a portfolio heavy on fixed income assets is prone to interest rate and inflation risks.

RISK is everywhere

Today, we are living with war, regional conflict, political instability, rising national debt and slowing economies, high inflation and several other risks. All of this impacts business, economies and performance of assets. 

RISK affects performance of different assets in different ways and understanding this is crucial to achieving a diversified portfolio.  

We could choose to spread our investments across stocks, bonds, bank deposits, real estate, commodities, cryptocurrency, art etc. Further, within asset classes we would need to look at diversification across large companies, small companies, geographic diversification, emerging markets etc. We could also diversify across different sectors/ industries, such as healthcare, technology, energy. 

ASSET ALLOCATION is imperative

With the help of a financial planner / adviser we could come up with an asset allocation based on our financial goals, risk tolerance, our current wealth/ savings, investment experience etc.

As the SEC explains, “Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.”

Each asset class comes with its peculiarities. For instance, commodities march to the beat of their own drum, which can help diversification. Supply movements can often be independent of the economic cycle. And while stocks and bonds may reward us with dividends or interest payouts, commodities do not offer this feature. Also, commodity ETFs may not come cheap, we may pay 0.8% a year in expense ratios for some of the more popular commodity ETFs.

How To Diversify Your Portfolio

While diversification can bring smoother returns, more predictability and reduced volatility in our portfolio it is important to remember that excessive diversification can be a losing game, it can mean lost returns/ potential for gain.

Yet, some risk may be necessary to meet our goals. For instance, if we are saving for retirement, it is likely that we will need to include some equity in the portfolio.

Determining our personal risk tolerance and investment goals is the first step. For example, we may be more inclined to invest in bonds or other fixed-income assets if we have a low-risk tolerance; if we have a higher risk tolerance, we may invest more in growth companies or early-stage start-ups.

Conclusion

Managing investments involves some science; we would benefit from using tools such as risk profiling, goal setting, diversification, asset allocation and periodic reviews with a financial planner.

As our portfolio grows and certain investments outperform others, it will be necessary to rebalance the portfolio to ensure that it does not become over or under exposed to the original plan. 

A properly diversified portfolio can help us reach our investment goals and give us peace of mind.

© Anu Maakan Feb 2024

Trends in global markets

We are witnessing extremely challenging times where cries of help, death and destruction are interspersed with financial troubles, inflation and yet progress, lives empowered by new technology, AI, new drugs and healthcare solutions.

The need for dominance (technological or otherwise), power play, regional conflicts and historical conflagrations are making for death, destruction, unstable geo politics, mistrust amongst trading partners, high inflation, energy shocks, human cost and displacement. Will this not impact your investments?

Here is a closer look at some key trends shaping our future.

Conflicts, Geopolitics and Volatility

‘This may be the most dangerous time the world has seen in decades and ongoing war in Ukraine and conflicts in the Middle East may have far reaching impacts on energy and food markets, global trade and geopolitical relationships’, said Jamie Dimon in a recent statement.

Central banks responded to the high inflation with the most aggressive global rate-hike cycle in decades; resulting in tighter credit, higher costs of doing business and forecasts of an impending recession.

Global debt has already hit a record $307 trillion in 2023. Experts predict more volatile business cycles, constraints on supply, shortfalls of demand and labour market shifts leading to economic fluctuations.

A bumpy economic landing seems inevitable as the economy sputters along; 6 out of 10 chief economists expect the global economy to weaken/ slowdown this year, as per the WEF.

As per this PIMCO report, ‘……..with the era of volatility-suppressing policies possibly over, markets are likely in for a period of heightened volatility, with an unusually large array of potential aftershocks.’

We would certainly do well to BUILD IN VOLATILITY into our investments decisions.

There are also reports of a drop in card spending in the US. Credit card spending was seen to be soft in September, across all sectors. ‘I think we are starting to see growing financial strain at the lower end of income levels’, said Citigroup economist Robert Sockin.

US – CHINA relations

The ever evolving US – China dynamic amidst the race for tech dominance continues to be at the cornerstone of geopolitics. This continues impacting the future of many corporations, such as NVIDIA due to the tighter restrictions on exports of hi tech items such as AI powered chips.

China is a larger story in itself. The slowdown and competition in China is beginning to impact the fortune of companies such as LVMH, Starbucks, Nike, Apple, Tesla, Rolex amongst others.

Barrons and The Wall Street Journal have reported these as impacted companies.

‘CASH is far from TRASH’

Last year was painful for fixed income investors in 2022 as they suffered losses on the back of rising interest rates. Higher interest rates have made holding cash more attractive, with many popular fixed-rate accounts paying over 5%.

Some banking stocks such as Bank of America and Goldman Sachs have benefitted from higher NII (net interest income) during this cycle of high interest rates.

Technology, Innovation, new DRUGS

In his recently published 7 page letter, “The Age of AI has Begun”, Bill Gates said that ‘The development of AI is as fundamental as the creation of the microprocessor, the personal computer, the Internet, and the mobile phone. It will change the way people work, learn, travel, get health care, and communicate with each other.’

Of particular interest are breakthroughs in AI, ML, Metaverse and VR (virtual reality), unlocking huge value across the business spectrum…. especially in healthcare, cybersecurity and semiconductors. There is a quiet convergence taking place – providing the grounds for a hyper connected, data driven world.

Recent drug discoveries and treatments in the areas of obesity, diabetes management, cervical cancer are heartening as they cater to huge markets.

Conclusion

‘Markets seem to be pricing the best of all worlds – inflation moderating, policy rates falling, and recessions evaded……. while attractive, the yield provided in ultra-short fixed income may be fickle, and kicking the can down the road on strategic allocations could prove costly for investors’, according to Goldman Sachs.

The key risk factors point to slower growth on the back of higher interest rates, ageing constraints for the workforce, geopolitical fragmentation of supply chains, technology led opportunities and disruptions. Mega forces are creating opportunities and risks across sectors and regions.

Yet, most agree that risks to growth are skewed to the downside and returns across asset classes are likely to be more differentiated.

© Anu Maakan October 2023

A closer look at Consumer Discretionary spend

Investing in Consumer discretionary stocks helps us profit from increases in our own non-essential spending as consumers.

Since consumer spending is something we possibly understand better than corporate spending, it makes this a very attractive sector to have a closer look at.

Demand for discretionary goods is cyclical and tends to rise and fall with the health of the economy. It is usually the first to suffer when we cut back spending on electronics, travel, durables etc. This makes these stocks more volatile compared to essential service providers.

Be it luxury, durable goods, home electronics, luxury, automotive, travel, leisure, entertainment – some of these companies command strong brand loyalty and premium pricing, with an ability to adopt dominant positions in their space.

Current economic scenario

The current economic landscape looks like this:

• Upward trends in wages and wage linked inflation in most of the US, Asia and parts of Europe.

• An environment of high interest rates and inflation leading to rising cost of products and services, thereby making a bigger dent in our savings.

(This is not ideal for the sector, as they make their money from consumer spending, and low interest rates usually stimulates spending. Between Dec ‘08 and December ‘15 — the Consumer Discretionary Select Sector SPDR Fund (XLY), rose more than 280% and outperformed the S&P 500 index, due to the near 0 interest rates).

• Most industry pundits are not predicting a recessionary environment, rather keeping a tight leash on super high growth via interest rate hikes.

Does this support growth of the consumer discretionary sector?

S&P500 Consumer Discretionary constituents and performance

The consumer Discretionary sector is approx. 10% weighting of the S&P500. It is the fourth largest segment after Information Technology, Healthcare and Financials.

Its performance has been leading the overall S&P500 performance and has provided 31% returns YTD, -37.58% in calendar year 2022, 24.2% in 2021, 32.07% in 2020, 26.2% in 2019 respectively.

Due to economic concerns linked to rampant inflation, lower purchasing power, and higher interest rates, the consumer discretionary sector displayed weak performance in 2022, as investors avoided cyclical sectors. However, the outlook improved in 2023.

Key Risks

• Consumer discretionary stocks can be significantly affected by the performance of the overall economy, interest rates, competition.

• This sector is also exposed to changes in consumer demand, consumer confidence and spending, changes in demographics and buying patterns.

• Rising input costs, including higher wages, can cut into margins or force companies to raise prices, which could reduce sales.

• Retailers and manufacturers of consumer discretionary goods are susceptible to supply chain disruptions, especially those with sprawling networks of suppliers.

Key factors to consider

Inflation has been high for a few quarters now and there is no sign of interest rate cuts just yet. This is not an ideal environment for the sector and some stocks have lost value together with the overall market.

Top holdings within S&P500 Consumer Discretionary by index weight are: Amazon, TESLA, Home Depot, McDonald’s, Lowe’s, NIKE, Booking Holdings, Starbucks, TJX Cos Inc, O’Reilly Automotive.

BofA Securities has recently upgraded consumer discretionary stocks from “underweight,” to “overweight”. Some of this optimism is based on expectations of a soft landing for the U.S. economy, improved revenue and earnings beats (relative to consensus analyst expectations) than the staples sector and credit/ debit card data showing that demand for goods is recovering, particularly for big-ticket items like homes and cars.

Some companies in the sector have shown strong growth and growth of new segments.

For instance, Lululemon Athletica, McDonalds and LVMH reported strong Q2 2023 results.

The sports apparel company had total revenues of $2.2 billion, up 18%, surpassing Wall Street estimates. McDonald’s reported second-quarter net income of $2.31 billion, up from $1.19 billion, an year earlier. Others such as Home Depot did not impress wall street and provided a negative guidance for 2023-24.

Until the economy shows strong growth and inflation starts to taper, stocks in the sector will carry some risk. The key will be to perform stock level analysis and pick stocks with a strong value proposition and growth, strong guidance and with reasonable current valuations.

Therefore, stock level analysis and risk assessment will be critical before making a purchase decision.  

The most popular ways to invest in the consumer discretionary sector are individual stocks, ETFs or Mutual funds.

© Anu Maakan September 2023

Investing in Aa+

The decision by Fitch to lower the US sovereign credit rating from AAA to AA+ came on August 1st, 2023.

The AA+ rating is one level below AAA, meaning that the US no longer has the highest credit quality. This is a response to the expected ‘fiscal deterioration over the next three years and repeated down-the-wire debt ceiling negotiations that threaten the government’s ability to pay its bills’, as per Reuters.

‘This basically tells you the U.S. government’s spending is a problem,’ said Steven Ricchiuto, U.S. chief economist at Mizuho Securities USA.

The US government debt now stands at over $31 trillion and is likely to reach 118% of gross domestic product by 2025.

The sovereign state is a profligate borrower and spends way above its means. To top it, the government bickers and regularly lands in stand offs. This has eroded public confidence in government fiscal management.

Is the downgrade simply a commentary on the viability of US debt? Or does it have wider ramifications? What does it mean for the investors in US assets? What does it mean for the future of the US dollar and that of Corporate America more broadly?

Investing in Corporate America

Corporate America is big, bold, innovative and largely profitable. It is defined by trillion dollar market cap, high end technology and turbo charged brands that are recognized globally. Yet can corporate America and its shareholders avoid being hit by the complications and cross-winds in the economy?

Stock Markets were hit after the Fitch downgrade. The Nasdaq Composite suffered its worst day since February, shedding 2.17%. The S&P 500 surrendered 1.38%, and the Dow Jones Industrial average slid 0.98%. Thereafter, news of a China slowdown and Moody’s downgrade of 10 banks has resulted in further fall in US indices.

Corporate America is under pressure, from its debt stockpile, from the slowdown in China, high interest rates, inflation, Moody’s downgrade of 10 US banks.

Can the superstar prodigy, i.e. Corporate America prosper in a dysfunctional family?

Here is what can go wrong:

Reduced off-take in US government debt and rising interest cost

The downgrade by Fitch could limit the number of investors able to buy U.S. government debt, especially those who are constrained by ratings.

Some investors who are required to put money only in AAA-rated securities may need to look elsewhere — though the number of other countries that still have the top rating is dwindling — potentially nudging up interest rates’, says the New York Times in this article.

What is likely to emerge is that rates will go up across the board on all sorts of debt to compensate for the added layer of risk. ‘The knock-on effects is that there will be higher mortgage and credit card rates,’ said Jon Maier, chief investment officer at Global X ETFs.

On the flip side, consumers could earn a more robust interest rate on fixed income products, resulting in a more balanced portfolio between stocks and bonds, if so desired.

Further fiscal deterioration and USD weakness

There is big possibility that the fiscal mismanagement will continue. ‘Fitch is not confident in policy measures being agreed and implemented to address the fiscal deterioration’, said Richard Francis, Fitch co-head of Americas sovereign ratings, in a Bloomberg TV interview.

‘The creditworthiness of U.S. treasury securities has long bolstered demand for U.S. dollars, contributing to their value and status as the world’s reserve currency. Any hit to confidence in the U.S. economy, whether from default or the uncertainty surrounding it, could cause investors to sell U.S. treasury bonds and potentially weaken the dollar’, says this article.

A depreciation in the US dollar may reduce demand for US assets and contribute to higher import costs, adding further inflationary pressures.

Over the longer term, investors may not find USD assets lucrative enough and may seek better returns elsewhere. This may further weaken the economy. 

Loss of confidence and a slowing economy

A downgrade could signal concerns about the country’s economic growth prospects, potentially impacting consumer and business confidence, foreign investment and economic activity. The US government may need to implement stricter fiscal policies, such as reducing public spending or raising taxes, in order to address the concerns raised by the downgrade and demonstrate their commitment to fiscal responsibility.

Further, due to the emerging dollar weakness, gold and other dollar denominated assets may start to lose value too. Events of such nature are also likely to induce further volatility in the US stock and debt markets.

To my mind, the potential economic slowdown, rising interest costs, further borrowings by the US government, volatility and weakness in the dollar will lead to a weakening value proposition for US Equity investors and future investments call for caution and selectivity.

© Anu Maakan August 2023

The WHY and HOW of investing in commodities

The commodity trading industry set an all-time record in 2022 for gross margin, surpassing $100 billion, as per a report from Oliver Wyman. Key commodities driving the rise in trade were oil and natural gas. Metals trading was active in 2022, but overall flows weren’t as disrupted by the energy crisis. Some agricultural products also saw strong global demand.

As per McKinsey, commodity trading value pools have grown substantially, almost doubling from $27 billion in 2018 to an estimated $52 billion of EBIT in 2021 (Exhibit 1). The majority of this growth was fuelled by EBIT from oil trading, which were estimated to have increased by more than 90 percent to $18 billion during this period.

Why Commodities?

We interact with several kinds of different commodities every day, directly in the form of food / farm products or in the form of inputs into end products. Main categories of commodities include:

Energy – crude oil, natural gas, refined products.

Precious Metals – Gold, silver, platinum and palladium

Agriculture – Grains, Soft commodities (such as sugar, cocoa), Livestock

Industrial Metals – Copper, Aluminium, Zinc and Tin

Commodities are ‘real assets’ that benefit from rising inflation. As demand increases, the price of these goods and the commodities used to produce those goods and services also increases; thus providing the portfolio with a hedge against inflation.

As per PIMCO, ‘Commodities are a distinct asset class with returns that are largely independent of stock and bond returns. Therefore, adding broad commodity exposure can help diversify a portfolio of stocks and bonds, potentially lowering the risk of an overall portfolio and boosting returns.’

Commodity prices are driven by the forces of supply and demand, and their prices are determined by a variety of factors such as competition, political and policy changes, macroeconomics.  

As per a World Bank report, ‘Global commodity prices fell 14 percent in the first quarter of 2023 and by end-March they were roughly 30 percent lower than their historic peak in June 2022.  The decline in prices reflects a combination of slowing economic activity, favourable winter weather, and a global reallocation of commodity trade flows. Commodity prices are expected to fall by 21 percent this year and remain mostly stable in 2024.

The EIU too expects most commodity prices, especially softs, to recede in 2023 in the face of slowing demand globally.

Pros of Investing in Commodities

• Commodities have low correlation to stocks and bonds illustrates what may be the most significant benefit of broad exposure to commodities: diversification. 
• As discussed previously, commodities are a hedge against inflation 
• Commodities give us exposure to underlying inputs rather than final product.

Cons/ Caveats of Investing in Commodities

• Commodity prices are easily influenced by events around the world; Example – oil price crash at the start of the pandemic and the ongoing hike in food prices after the Ukraine war.
• Commodities may not perform well during cyclical downturns in the local or global economy, when consumer and industrial demand slows. Treasury Secretary Janet Yellen recently told Bloomberg that China’s slowdown could have a “negative” impact for other economies, including the United States.
• More severe trade flow disruption scenarios could occur, including the potential formation of trade blocs, with the impact felt differently by each commodity class.
• Commodity trading can be complex and requires good SME knowledge of the underlying products, trading opportunities and emerging trends.
• The volatility of spiking commodity price levels has significantly tightened collateral requirements and increased the size and frequency of margin calls. This may continue to be the case.

How to invest in Commodities

Individual securities –  we can get indirect exposure to the commodity market by buying and selling the shares of companies that are involved in the mining, extraction, growth or harvesting of any type of commodity.

Physical ownership – This is the most basic way to invest in commodities. But unless these are small, transportable assets like precious metals, it can be impractical.

Futures and Options contracts – These contracts are available on every commodity you can think of, and they’re traded widely across the world. The vast majority of commodity based financial instruments are traded by professional investors and fund managers.

Mutual funds, exchange-traded funds (ETFs) and exchange-traded notes (ETNs) – these provide exposure to a range of commodities or commodity-linked stocks from a single position. Some ETFs hold physical assets while others synthetically mimic the underlying market. Commodity index funds can provide exposure to a cross-section of commodities.

Hedge funds or private investments specializing in commodities are also an option, albeit these are more complex and carry a high degree of risk and volatility.

Trends to consider

The post-global financial crisis era of loose monetary policy and low and steady inflation has since come to an end. Most pundits predict a more persistent inflation in future. This bodes well for opportunities in commodity trading in general, though specific opportunities will need to be scouted.

Some factors to keep in mind as we try to make commodity picks:

• The effects of climate change and adverse weather events
• Trends in oil consumption and alternate energy sources
• ‘Possible disruptions in the supply of energy and metals (in part due to trade restrictions), intensifying geopolitical tensions’, as per the world bank.
• War in Ukraine may still affect agricultural commodities markets in 2023.

As per McKinsey, ‘Commodity trading is on the cusp of the next normal. The energy transition will cut across and integrate the various global food, energy, and materials systems. This transformation is likely to increase structural volatility, open new arbitrage opportunities, redefine what it means to be a commodity, and fundamentally alter commercial relationships. All these developments will create unique opportunities and challenges.’

© Anu Maakan July 2023

The weakening case for equities amidst bank failures

HSBC is buying out the UK subsidiary of S.V.B. (Silicon Valley Bank) for £1. Yes!

Something must have gone seriously wrong? Yes!

Explained simplistically, S.V.B. invested large sums into long-dated securities. With the Fed’s drive to increase interest rates, its investments began to lose value and investors started to pull out funds. It was also functioning without a head of risk for several months.

Federal regulators have announced that all customers of both SVB and Signature Bank would have access to their money. The immediate turmoil in the US banking sector seems to have been arrested.

This episode raised additional questions for the sector. Are there other banks vulnerable to interest-rate risk? Will the acquiring institutions be as friendly to start-ups as S.V.B.? Who will start-up founders trust with their money….. and will they continue to be funded as before?

Let us not forget the underlying issues forces that led us here:

• The Fed’s unrelenting focus on bringing down inflation via increasing interest rates (and hence the reduced valuation of bank stocks).
• Poor risk management practices at some banks.
• Reduced regulatory scrutiny on banks, following on from Trump’s populist era.

Jim Reid and a team of strategists at Deutsche Bank explained, ‘SVB’s woes are a combination of one of the largest hiking cycles in history, one of the most inverted curves in history, one of the biggest bubbles in tech in history bursting, and the runaway growth of private capital. ………. it’s just more of the boom-bust cycle we’re stuck in.’

In the aftermath of the 2008 financial crisis, Congress passed the Dodd-Frank Act to protect consumers. Wall Street chief executives, their lawyers and lobbyists spent millions trying to defeat it. Greg Becker, the chief executive of S.V.B. was one of them.

Biden has started to talk about bringing back more banking regulation!! When will those kick in? What will they entail?

Bank runs are considered quite dangerous because they may induce panic and concern amongst customers about their own deposits. In an interview on Sunday, former FDIC chairman William Issac said ‘there’s no doubt in my mind: There’s going to be more. How many more? I don’t know.’

There are big clues that there’s more pain to come, look to the market. There is potential for a cascade of bank failures, reflected in their shares prices on Monday.

First Republic, PacWest, Western Alliance, and Charles Schwab are among the major names that sank on Monday as investors grew anxious about banks’ ties to the tech industry and their massive unrealized losses. According to the FDIC, at the end of 2022 US banks were sitting on $620 billion in unrealized losses on their bond assets. 

Moody’s Investors Service has downgraded the ratings of the collapsed Signature Bank to junk. It has also put the following six banks under review – First Republic Bank, Zions Bancorp., Western Alliance Bancorp, Comerica Inc, UMB Financial Corp and Intrust Financial Corp.

A volatile future!

Does the global economy remain a fundamentally sound place? Will there be more surprises in the stock markets?

Equity investing seems to have gotten more complicated and vol. Some factors to consider:

• What about escalations in the Russia-Ukraine war and its impact on supply chains and cost structures across the world?

• Will the inflationary risk and interest rate risk spill over to other sectors?

• Could there be an impending funding crisis for technology companies/ start ups?

• What about the impending recession, cost increases and unemployment resulting from central bank policy?

• Could political tensions mount, especially that of US-China and in South Asia under China’s growing need to show dominance?

There seems to be a more stock market volatility coming our way and certainly not the tail end of bad news.

© Anu Maakan March 2023

Results speak!

Some of us have bid farewell to that exotic holiday, the new vehicle, yet others have cut down on shopping/ grocery trips, deferred a gadget purchase to that Christmas sale – all in the midst of an inflationary onslaught. While not all consumers are not behaving in the same way, and sufficient numbers are earning big dollars, yet some belt tightening is evident.

Pullback in consumer spending, higher costs, political bickering and conflict / wars are impacting corporate results. Margins are under pressure as companies face higher costs, lower margins and overall higher inflation.

Wage bills, energy and raw material costs together with overall supply chain constraints is not painting a pretty picture either. While some businesses are trying to cover rising labour costs and higher input prices, others are increasing prices to swell their profits.

Slowdown in corporate revenues / profitability and lower guidance is manifesting in layoffs, spending cuts and impending consolidation. As per Layoffs.fyi, major tech companies have announced about 100,000 layoffs this year.

Suspicions of an extended slowdown are being confirmed by industry experts. Goldman Sachs group has lowered earnings estimates for the S&P500 index for each year until 2024, saying margins contraction in the third-quarter signals more pain ahead. Inflationary years with high interest rates are lie ahead.

What Tech Corporate Results are telling us

Tech companies, which led the U.S. economy and stock market upwards, have declared poor Q3 2022 results, confirming the impact of global economic jitters, soaring inflation and rising interest rates.

Social media companies too have seen a pullback in digital advertising, smartphone and computer sales and cloud computing are showing signs of slowdown. Some shoppers have enhanced spending on travel, concerts and sports, rebuilding on experiences.

Here are key highlights from some tech company results for Q3 2022. Amazon sawnet sales increase 15% to $127.1 billion in the third quarter, compared to $110.8 billion in Q3 2021; yet this fell short of wall street expectations. Net income decreased to $2.9 billion, Operating cash flow decreased 27% to $39.7 billion, compared to $54.7 billion for the trailing twelve months ended September 30, 2021.

AWS declared revenues of $20.5 billion vs. $21.1 billion expected, accounting for all of the company’s profit, with an operating income of $5.4 billion; yet this was its slowest growth since 2014. AWS saw 200 points of margin compression. Data centers and hardware are driving up the company’s costs. Amazon expects fourth-quarter revenue between $140 billion and $148 billion, as against street expectations of over $155.15 billion.

Microsoft shares have fallen over 20% so far this year, while the S&P 500 stock index is down 19% over the same period.

It declared revenues of $50.1b, an increase of 11%, with an operating income of $21.5 billion (up 6%). Net income at $17.6 billion and was down 14%.

It also gave a guidance $52.35 billion to $53.35 billion in revenue for the fiscal second quarter, which implies 2% growth at the middle of the range (as against street expectations of revenues of $56+ billion). 

Similarly, Apple has shown revenue growth of only 2% year-on-year, closing at $83billion. iPhone sales were at $40.67 billion vs. $38.33 billion estimated and service revenue at $19.60 billion (up 12%). This sudden slowdown in tech earnings is exposing a weakness. They haven’t really found a new, very profitable idea in years. The iPhone, 15 years after it upended the industry, still drives Apple’s profits.

The computer market is fast deteriorating. “There were so many PCs purchased in the last two years that there’s no demand,” said Mikako Kitagawa, a technology analyst with Gartner, a market research firm. “Plus, hiring is frozen, so businesses don’t need new PCs.”

Industry researcher Gartner said earlier this month that PC shipments in the quarter fell 19.5% year over year, and chipmaker AMD issued lower-than-expected preliminary quarterly results tied to a weaker than expected PC market and significant inventory corrective action across the PC supply chain.

GOOGLE reported revenues of $69 billion for the quarter, up six percent versus last year.  Operating and Net income were down by around $4 billion and $5 billion, respectively. The company saw search ads rise only 4% in the third quarter, and YouTube and third-party ad networks each fell 2%. 

Google Cloud reports revenue of $6.86 billion, up from $4.99 billion in 2021. Its losses widened slightly, from $644 million to $699 million.

Sundar Pichai, CEO of Alphabet and Google, said: “We’re sharpening our focus on a clear set of product and business priorities. Product announcements we’ve made in just the past month alone have shown that very clearly, including significant improvements to both Search and Cloud, powered by AI, and new ways to monetize YouTube Shorts. We are focused on both investing responsibly for the long term and being responsive to the economic environment.”

Despite years of investment in new businesses, Google and Meta still rely mostly on ad sales, leaving them vulnerable to the disruptive upstarts that they once were. YouTube, which is owned by Google, and Meta’s Facebook and Instagram social media platforms are being challenged by the much younger TikTok.

A few days later, the chip maker Intel announced a $10 billion cost-cutting program and lowered its profit forecast for the year. “It’s just hard to see any points of good news on the horizon,” its chief executive, Patrick Gelsinger, told investors.

Demand could begin to wane for more products and services as families spend down their pandemic savings and struggle to keep up with climbing costs, especially if the job market begins to slow.

With massive layoffs being announced by tech companies, costs will come down and the market may begin to appreciate the belt tightening, as it has done after the announcement of 10,000+ layoffs by META. Improved CPI data has also cheered markets in the last few days.

Yet, the era of explosive growth and low inflation are over. Market pundits have announced the onset of an inflationary decade.

© Anu Maakan 2022

The Irrefutable Opportunity in Emerging Markets

Where would you rather place your bets?

Strong growth, entrepreneurial energy, high spending! OR Flattening demand, ageing populations and sluggish spending?

By 2025, Emerging economies will account for an annual consumption of $30 trillion, nearly 50% of the world’s total. In 15 years, almost 60% of the one billion households with earnings greater than $20,000 a year, will live in the developing world, as per McKinsey Global Institute. Income levels have risen faster than the developed world. A large proportion of these are young consumers with high propensity to spend.  

World Population & Consumption
(Source: McKinsey Global Institute)

As  per J. P. Morgan Asset Management, ‘Gone are the days when emerging market investing was merely about industrials and commodities. The story is now much more about millennial demand and rising e-commerce, and the increased demand for health care and financial services that comes with rising affluence.’ Emerging Markets now account for approximately 36% of the global GDP.

Contribution to annual global real GDP growth
(Source: JP Morgan Asset Management)

Does that look like a story you could ignore?

Wide spectrum of Growth

Emerging markets have come a long way from the financial crisis of 1997. They have invested in structural reform, fiscal consolidation, infrastructure, technology, education and in new enterprise. They have embraced innovation, technology and digitisation; thereby improving productivity, economic and income growth.

The MSCI Emerging Markets Index comprises 27 countries, representing almost 12% of the MSCI ACWI Index, a big change from 1987 when it was launched with 10 countries, totalling less than 1% of the global equity market.

MSCI Emerging Markets Index
(Source MSCI)

China constitutes 39% of this index, followed by South Korea (13.46%), Taiwan (12.75%), India (9.25%), Brazil (5.1%). While the BRIC (Brazil, Russia, India, China) nations have been noticed for quite some time, powerful opportunities have manifested in the likes of South Korea, Taiwan, Mexico.

China is vying for the top spot in 5G, Artificial Intelligence, Digital currencies, EVs (Electric vehicles) and Robotics. As per OECD, China’s R&D expenditure now equals that of the United States and it no. 10 on the Global Innovation Index.  

Taiwan, South Korea, India, Mexico and a few other Latin American countries remain attractive. Convinced by its economic growth, the FTSE reclassified South Korea as a Developed Market, back in 2009. ‘South Korea is the 15th largest economy measured by GDP, industrial output and services ….. it is home to some of the world’s biggest and most successful corporations, has a thriving high-tech industry and a high-tech population……’, as per the World Bank in this white paper.

Taiwan, home to some world class companies such as Taiwan Semiconductors has been performing well on the stock markets.

Performance Trends & Expectations for 2021

The recovery in emerging markets equities that began in late March picked up steam in Q4 2020, thanks to COVID-19 vaccine, stimulus packages, rate cuts and clarity brought by US election results. The expectation is that economies will benefit further as the vaccine is distributed in the first half of 2021.

2020 Equity Markets Performance
(Source: MSCI)

The MSCI China Index has beaten other MSCI index for YTD returns in 2020, beating other MSCI index. They also declined the least from 31 Dec 2019 to 23 March 2020. Even so, Emerging markets have generally lagged behind U.S. equities. This is primarily because the U.S. stock prices have had a steep upward incline in the last ten years.

Asian stock markets have shown strong performance in 2020, led by China, South Korea, Japan, Taiwan and India.

Asian Stock Market Performance
(Source: CNBC)

As the world economy emerges from one of the deepest recessions, all regions are expected to grow in 2021. Rollout of the vaccine, reopening of economies and infrastructure overhaul is likely to trigger demand for cement, energy, heavy machinery, materials, and industrial products, commodities, further spurring Emerging Markets.

Advanced economies are predicted to grow at 3.3% & 3.5% in 2021 and 2022, while the EMDE (Emerging Market and Developing Economies) growth is envisioned at 5% in 2021 and 4.2% in 2022, as per the World Bank (Global Economic Outlook, January 2021). Inflation is also expected to remain low in most markets.

What could go wrong?

Even under a new US administration, trade tensions with China may continue. Some companies have been asked to delist or comply with new requirements from the US stock exchanges, there may be others in the pipeline. Many Chinese companies are looking to list on exchanges in China or go private, rather than meet demands from Trump administration. All of this adds to the uncertainty and mistrust, none of which serves stock markets well.

Neither should we ignore the noise emanating from China. Not only did the Shanghai Stock Exchange halt the $37 billion IPO for the Ant Group on grounds of transparency, they also opened an investigation into Alibaba for alleged monopolistic practices. We surely need to watch this space.

As emerging market investors, we should also pay attention to currency and commodity price fluctuations. Exports suffer when commodity prices decline and local currencies fall.

How to invest in Emerging Markets

Be it stocks, bonds or almost any other asset class, foreign cash is pouring into Asia on bets that it will fast recovery and growth.

The region’s currencies and commodity prices are seeing an upward trend too. Most are expecting a controlled virus situation, improved global growth and ample liquidity to spur growth and inflows into the region. The pandemic is not expected to alter the long-term growth trajectory of emerging markets and will be a valuable inclusion in your portfolio.

Dollar weakness is likely to continue in the face of low interest rates, printing of more stimulus cheques and a widening fiscal deficit. Stronger economic growth in the Emerging markets will drive returns, currency strength and yields, thereby attracting investors.

You could invest in Emerging Markets via ETFs, Mutual funds or even stocks listed directly on large exchanges. Options include Broad-based, Country-specific, Theme-specific) funds/ ETFs, Commodity & Index funds/ ETFs and Direct stocks.

If anything, the pandemic in 2020 has demonstrated its disparate impact in different parts of the world and made a strong case for diversification and global asset allocation. Over reliance on a single market or currency is certainly not the way forward.

© Anu Maakan January 2021

https://anumaakan.wordpress.com/

(Disclosure: This article is for informational purposes only and is not investment advice of any investment strategy) 

The promise of 2021

Endings can sometimes be more pleasurable than beginnings, and we can certainly say that for 2020.

Covid-19 has claimed over 1.5m lives, infected nearly 65m people and decimated several million livelihoods. While the struggle with Covid19 is beginning to recede in some parts of the world, it is still out of control in parts of US, Asia, Europe and Africa.

An accommodative stance from governments, reduced political uncertainty, ongoing infusion of fiscal and monetary stimulus and visibility to treatments and vaccines to treat Covid19 have inspired hope. This resulting confidence has provided a boost to stock markets around the world.

On a positive note, as much as 2020 stood for loss, death, uncertainty, historic debt burdens, fiscal deficits, and damaged investor sentiment, it has also unleashed several decades worth of innovation and change, digital transformation, higher adoption of e-commerce, home entertainment and remote work. Some of these trends are likely to carry through into 2021.

Talking about 2020

(MSCI Emerging Market, ACWI and World Indices, source: MSCI)

More than $100b has flowed into global equity in November 2020. The MSCI world Index was up 13.5% in November 2020 alone, while the S&P 500 (3699.12) and Dow Jones (30218.3) touched new highs on Dec 4, 2020.

Meanwhile, holiday shoppers in the US spent $10.8 billion on Cyber Monday, setting a record for the largest US online shopping day, according to this report. Also, retail sales in China hit record highs in November, beating the US retail sales.

(S&P 500 and Dow Jones Industrial Average 1 year performance; source: trading view)

The rally reflects investors growing eagerness to buy into risky assets, encouraged by progress in the development of Covid-19 vaccines, the cheaper US dollar and overall optimism for 2021.

Gold, Other assets

Gold has outperformed the S&P 500 over the last 1 year, 3 year period and touched its all-time highs on 6^th August 2020 at $ 2067.2, breaking its previous record of 2011. This run-up has reinstated the ‘safe haven’ status of gold, as was the previous instance in 2011 where the global financial crisis drove people to invest in the yellow metal.

Gold prices are expected to strengthen further. ‘Continued quantitative easing by global central banks, a weaker trajectory for the dollar and real rates dipping further into negative territory should all underpin demand for gold’, according to Pictet Asset Management.

(US Dollar Index, source: DailyFX)

The US Dollar Index has fallen by over 10 points from April to December 2020. With the political uncertainty in the US and the severity of pandemic, investors stockpiled into the dollar seeking a safe haven…. However, as things return to normalcy, investors will seek out riskier assets. Expectations of further stimulus and ongoing low interest rates, are likely cause further dollar weakness.

A weaker US dollar can lift foreign assets, and raise the attractiveness of risk assets such as emerging market stocks, momentum stocks, even commodities like Gold and Oil which are pegged in USD. 

Lifting the veil on 2021

Better times seem to be around the corner. Yet, we don’t know everything!

Governments face an uphill task of immunising their populace, rebuilding economies, public health and pushing growth. At best, 2021 may turn out to be an year of transition and renewal; at worst, it may include destabilising surprises and unexpected curveballs.

‘Positive base effects cannot hide the long-lasting damage caused by the pandemic – our economists estimate that because of Covid-19, global GDP is permanently 4% smaller’, says Luca Paolini of Pictet Asset Management. He estimates global growth at 5.6% in 2021, while the IMF has predicted growth rates of 5.2% in 2021; with advanced economies projected to grow at 3.9% and emerging markets & developing economies at 6%.

Stock market in 2021

The more popular and widely accepted scenario building up for 2021 is that of a bullish Goldilocks market for equity markets, i.e. steady economic recovery with low inflation expectations. This would be the most favourable case for equities and could deliver broad based gains to investors. This would be based on:

Effective & timely roll out of the vaccine and other treatments would lead to steady reopening and normalisation of economic activity. However, recovery timelines are dependent on vaccine rollout speed and percentage of population covered. Large-scale immunisation are expected to start happening by mid 2021.

Decline in unemployment, stable inflation rates and monetary policy stays moderately loose. The IMF predicts inflation to remain low. ‘In line with the subdued outlook for activity, inflation is expected to remain relatively low over the forecast horizon. Inflation in the advanced economy group is projected at 1.6 percent in 2021 and broadly stabilizing thereafter at 1.9 percent. In the emerging market and developing economy group, inflation is projected at 4.7 % percent next year, and moderating thereafter to 4%, over the medium term.’

Pent-up demand. People have been putting-off purchases, while piling up on savings. They also got stimulus checks and other forms of payments. Spending is likely to catch-up as the economy continues to open up.

Further stimulus would be needed to get economies back on track. While there is poor clarity on the specifics of the US stimulus package, there are indications that bipartisan support is gathering in the Senate for a $908 billion stimulus package.

Possible challenges for 2021

The debt burden – economies face an uphill task of rebuilding their economies while avoiding further debt build-up. The IIF said global debt would break new records in the coming months, to reach $277 trillion by the end of the year. This would represent a debt-to-GDP ratio of 365%. ‘We expect a world that is more indebted, more unequal, and more local to result in below-average long-term returns across traditional asset classes’, says UBS Wealth Management.

Sticky Geo-politics – tensions between the US and China remain elevated. Expectations are that these will only amplify further, causing more uncertainty and volatility in the currency and stock markets. Not only did the outgoing Trump administration blacklist CNOOC and SMIC, they also passed legislation on Wednesday that would increase oversight of Chinese companies listed on American stock markets. The SEC has also proposed regulations that would prohibit Chinese companies from conducting initial public offerings on American stock markets. 

In case of a resurgence of the virus, slow progress or unequal access to treatment, economic activity could be lower than expected, with renewed social distancing and tighter lockdowns. Renewed bankruptcies may also compound job losses and rising debt. Some studies are already reporting issues with the vaccines.

There are also risks of increase in inflation expectations on the back of a strong recovery. This may force the Fed will be to raise rates, which could lead to a cascading debt spiral, much like the effects of the financial crisis.  This is a significant tail risk and one to watch for.

We also need to be aware of systemic risks from a hyperconnected world. We cannot rule out the possibility of future pandemics, climate change or other catastrophic risks.

Cautiously optimistic, long-term investing is still fashionable. Hold on to those well intentioned, highly researched and fundamentally strong investments, as you gear up for 2021.

© Anu Maakan December 2020

https://anumaakan.wordpress.com/