Add cyclical stocks, says Morgan Stanley

Economies move in cycles. However, these cycles only matter for financial markets at turning points because most of the time the economy is in an expansion phase. Such turning points include periods when growth accelerates or decelerates, but the economy is still expanding. Economic recessions are different, however. These are periods when growth is actually negative and the economy is shrinking. Recessions are also rare, occurring just once per decade in the US.

Therefore, it makes sense that a good part of our investment strategy research centers around cycle analysis. We find it very useful and profitable when properly interpreted. As discussed over the past few months, when it becomes obvious to everyone we're entering an economic recession that usually marks the end, rather than the beginning, of the bear market. In fact, we've shown in our research just how similar this cycle has been to prior recessions with respect to financial markets.

Of course, all economic cycles are unique in some way too, which can affect the rate and sustainability of the recovery while also determining both new opportunities and areas ripe for disappointment. With respect to this recession, we think the primary differentiating feature is the nature of the exogenous shock that triggered it. The pandemic provides a faceless villain that everyone wants to defeat but can't really punish for our economic hardship. In short, there are no bad actors in this recession. This has liberated policymakers to do whatever it takes, both on a monetary and fiscal front, and that is what's very different this time when thinking about the recovery.

More specifically, after the Great Financial Crisis recession of 2008, we got unprecedented monetary policy support with central banks introducing quantitative easing, or QE. To the average person, QE is better known as "money printing." However, these QE programs were uncoordinated at first, with the U.S. initiating its QE program in late 2008, while Japan and Europe waited several years. This time, all three major central banks are printing money at the same time, with the Fed printing more money in this current program than they did in the following three years after the financial crisis.

We're also getting fiscal support this time. After the financial crisis, many governments practiced fiscal austerity, whereas this time we are seeing record setting fiscal deficits led by the US. This coordinated policy mix has led to much faster growth in the money supply. And money supply is a function of both the amount of money on the Fed's balance sheet and the velocity of money in the real economy. This money is flowing into asset prices, but it's also flowing into the real economy. And it's just one more reason why we will likely remain more optimistic on both the rate and sustainability of the recovery. It also means we will continue to suggest investors look for more cyclical stocks as they add equity risk to their portfolios.
- 26 May 2020

Some ideas of cyclical stocks (semiconductors, oil) have been covered in recent articles in this blog.

Robust outlook, limited Covid-19 disruptions for semiconductor stocks: Maybank

SINGAPORE (May 19): Amid the Covid-19 pandemic, semiconductor and equipment companies have been deemed “critical” in many countries. 

Maybank Kim Eng Research analyst Lai Gene Lih says that this means the odds of further virus-induced disruptions to stocks such as UMS Holdings and AEM Holdings are unlikely. 

In fact, the industry’s demand remains intact with supply reverting back to normal levels. 

“Contingent on fundamentals staying intact, we remain accumulators on dips for AEM and UMS,” says Lai in a Monday report. 

Lai notes that AEM and UMS both posted “solid” 1QFY2020 results, and the read-across for both companies remains favourable. Intel and Applied Materials (AMAT), the respective key customers of AEM and UMS, are also progressing with leading edge investments and record orders. 

For AEM, Lai says Intel’s continued spending on 10, 7 and 5nm chips could be a key driver for the counter’s prospects. 

 “While Intel’s “more disciplined” approach to 2020 capex likely infers slight downside to the US$17 billion guidance earlier in the year, it emphasized that spending for 10, 7 and 5nm will be on schedule,” says Lai. 

According to Lai, Intel is banking on a strong data centre business in 1H2020 but is bracing for weaker enterprise and government demand in 2H2020.  

“Intel also sees 2H2020 headwinds from softer PC demands, as well as industrial, retail and automotive end-markets,” says Lai. 

However, he is quick to note that Intel not only has major design wins from Ericsson, Nokia and ZTE, but is also a major silicon provider for 5G infrastructure. 

For UMS, Lai shares that AMAT has enjoyed record orders in 2019, a signal that the company’s demand fundamentals have not been adversely affected by the pandemic. 

“Drivers are unchanged, being sustained spending from logic and foundry as chipmakers continue with development plans at the leading edge, and improving dynamics that is supportive of increased memory investments through FY2020,” says Lai. 

Furthermore, AMAT’s Endura platform, which UMS assembles modules for, is a flagship product for physical vapor deposition (PVD). 

AMAT is also looking forward to strong double-digit growth for the year on the back of a single digit increment in 3QFY2020, followed by a further increase in 4QFY2020.

“AMAT is not seeing strong capacity additions from memory customers, but investments based on technology roadmaps are progressing to plan as this affects the cost structure of memory chipmakers when industries recover,” says Lai. 

“Research found that AMAT gained significant share in PVD in 2019,” observes Lai. “AMAT’s view for sequentially higher revenues over the next two quarters present upside potential for UMS, in our view,” he adds. 

To reflect AMAT’s strong momentum in the near term, Lai has raised its FY2020-22E earnings per share (EPS) forecasts by 3-5%, which would translate to an average return on equity (ROE) of 17.7% for the period. 

Maybank is reiterating its “positive” stance on the semiconductor equipment sector. The brokerage also has “buy” calls on AEM and UMS with target prices of $4.04 and $1.00 respectively. 

As at 12.21pm, shares in AEM are trading five cents higher, or 1.7% up, at $3.07 while shares in UMS are trading one cent higher, or 1.1% up, at 91 cents. 

STI a long term buy

According to Dr Tee's optimism model (updated 14 May 2020), STI is now sitting on long term buy.

Morgan Stanley says we are at the beginning of a new bull market

Today’s stock market looks like March 2009, before the longest bull run in history,

says Morgan Stanley’s Mike Wilson

Published: May 18, 2020 at 12:04 p.m.

By Chris Matthews

Stocks’ value relative to bonds is equal that of 2009

As investors navigate the coronavirus recession, the financial crisis a decade ago looms
large in their collective memory, with pessimists arguing that the resulting bear market
took 18 months to hit its lowest point and optimists countering that swift and decisive action
from the Federal Reserve and Congress this time around has saved the stock market from
that fate.

Michael Wilson, head of U.S. equity strategy at Morgan Stanley is squarely in the bull camp,
arguing in a Monday note to clients that the current stock market looks uncannily like
March 2009, when the U.S. economy was emerging from the crisis, and the
S&P 500 index SPX, +3.15% was beginning its longest bull-market run in history.

“Markets are tracking the Great Financial Crisis period very closely in many ways,” Wilson
wrote, adding that stocks have rebounded in a “similar pattern” to March 2009, at the same
time that the number of individual stocks trading above their 200-day moving average has
begun to climb, supported by “cyclical stocks” like small-capitalization stocks, which typically
lead at the beginning of recoveries.

Another important similarity between the two periods is the equity-risk premium, or 
the expected earnings yield for the S&P 500 minus the 10-year Treasury yield, which 
gives investors a rough estimate of the extra return they’ll get investing in stocks compared 
with risk-free government bonds.

“A significant driver of our bullish call in March was based on the equity-risk premium

reaching the same levels observed in March 2009,” Wilson wrote, referring to his calling a 

stock-market bottom on March 16, just a week before the S&P 500 closed at its recent 

low of 2,237 on March 23.

“If there’s one thing we’ve learned over the past 10 years, it’s that when risk premium 

appears you need to grab it before it disappears,” he said. The risk premium will fall either 

when bond prices fall and interest rates rise or when equity prices rise, thereby reducing 

their expected return.

Though traditional cyclical stocks like small-caps have outperformed of late — the Russell 2000 RUT, +6.10% has risen 8.3% during the past month versus the S&P 500’s 2.9% rise.

— others, like financial stocks have not. In fact, bank stocks are performing worse relative to

the S&P 500 than during the bank-driven financial crisis.

Wilson explained this dynamic by arguing that the very same Fed stimulus that has

truncated the coronavirus bear market is repressing government bond yields in a way that is 

scaring bank investors. “The biggest headwind for banks is the persistently low level of rates,” 

particularly for longer-term debt, Wilson wrote. Low interest rates hurt banks because they 

lower the profit margins they can earn by issuing loans.

But Wilson believes the market is underestimating the chances that longer-term bond yields,

like the benchmark 10-year U.S. Treasury note TMUBMUSD10Y, 0.705%, will rise

significantly as the economy rebounds from coronavirus, and is therefore underestimating 

chances for a huge rally in financial-sector stocks.

He pointed to Congress passing at least $3 trillion in fiscal stimulus, the potential for a faster

and more sustained recovery in the post-coronavirus economy and unexpected inflation as

demand returns before supply chains can adjust as possible catalysts for higher inflation and

long-term interest rates.

“While hypothetical, these are real possibilities and worth considering given current levels of

inflation and 10-year Treasury yields,” Wilson wrote. “We continue to think higher 10-year

rates would be perhaps the biggest surprise to markets at the moment and would have 

significant implications for equity markets and leadership.”

Wilson explained this dynamic by arguing that the very same Fed stimulus that 
has truncated the coronavirus bear market is repressing government bond yields in a 
way that is scaring bank investors. 

“The biggest headwind for banks is the persistently low level of rates,” particularly 
for longer-term debt, Wilson wrote. Low interest rates hurt banks because they lower the 
profit margins they can earn by issuing loans.

But Wilson believes the market is underestimating the chances that longer-term bond
yields, like the benchmark 10-year U.S. Treasury note TMUBMUSD10Y, 0.705%, will 
rise significantly as the economy rebounds from coronavirus, and is therefore 
underestimating chances for a huge rally in financial-sector stocks.

He pointed to Congress passing at least $3 trillion in fiscal stimulus, the potential for a
faster and more sustained recovery in the post-coronavirus economy and unexpected 
inflation as demand returns before supply chains can adjust as possible catalysts for 
higher inflation and long-term interest rates.

“While hypothetical, these are real possibilities and worth considering given current levels
of inflation and 10-year Treasury yields,” Wilson wrote. “We continue to think higher 
10-year rates would be perhaps the biggest surprise to markets at the moment and would 
have significant implications for equity markets and leadership.”

Why Goldman Sachs Says The Market Is In For An 16% Drop Soon

•  May 14, 2020

Pessimism is soon to take over the FOMO that has been driving the market higher since the March bottom. Here’s why. 

As cases of the coronavirus climb to more than 1.4 million in the U.S. and jobless claims rise past 36.5 million since the start of the coronavirus crisis, many are scratching their heads over why the market has been rallying higher amid the worst economic picture seen since the Great Depression.

Goldman Sachs said this week that FOMO, or the Fear Of Missing Out, is what has been driving the market higher. That FOMO appears to be overshadowing the fear of all that’s wrong with the economy.

However, Goldman believes that pessimism will soon take over the market, sending the S&P 500 down nearly 16% over the next three months. 

Goldman chief U.S. equity strategist David Kostin wrote in a report this week that even as fiscal and monetary policy support has helped ward off a full blown financial crisis amid the pandemic, a return to normalcy is still a long way off and investors have gotten ahead of themselves.

“The ‘fear of missing out’ best describes the thought process,” Kostin said as investors feel pressure to chase the recent rally, while warning that it’s a risky move.

“Skepticism abounds regarding the likelihood the rally will continue,” Kostin wrote.

“In six weeks, as the S&P 500 index has soared by 30%, investors have raced from despair at the market bottom to optimism about the economic restart,” Kostin wrote in a note to clients. “A single catalyst may not spark a pullback, but concerns exist that we believe, and our client discussions confirm, investors are dismissing, including $103 billion in expected bank loan losses in the next four quarters, lack of buybacks, dividend cuts, and domestic and global political uncertainty.”

Goldman expects the S&P 500 to drop to around 2,400 over the next three months before rebounding to around 3,000 by the end of 2020. 

Kostin noted that one of the biggest risks moving forward is that investors have been too optimistic that the COVID-19 epidemic in the U.S. has been contained. 

“While New York has thankfully been able to flatten the curve and the rate of growth of new cases has decelerated, new infections in the rest of the U.S. are increasing,” Kostin wrote. “Cases of infection may accelerate as states begin to relax shelter-in-place rules.”

He also warned that “the restart process will take time,” noting that company conference calls with analysts indicate that many executives are predicting a slow recovery to pre-coronavirus crisis profit levels. 

Aside from the domestic picture, Kostin added that “investors may need to contend with another twist in U.S.-China trade and strategic developments, which was at the forefront of investor concerns for much of 2019. The nature of the tension seems multifaceted, going beyond conflicts in merchandising and service trades, with the U.S. administration’s rhetoric and actions towards China turning more hawkish in the past month across various issues and strategic domains.”

THREE REASONS THIS RECESSION WON'T BE WORSE THAN THE GREAT DEPRESSION

1. Unemployment Figures Do Not Paint a Complete Picture

The U.S. economy is losing millions of jobs – there is no sugar coating this fact. But if we take a very close look at the job losses across the economy, we find that a large percentage are furloughs (temporary layoffs) as opposed to permanently shrinking the workforce (data below):

Source: : Zacks Investment Research³

In the current environment, employers appear to be keeping employees close by, in anticipation of the economy’s reopening. A recent survey conducted by Morning Consult found that two-thirds of workers believed that they would return to work for their current employer, which could help restart business much more quickly than if the employer had to rehire.⁴ When employees are asked to return to work, there’s no need for training, recruitment, job search, background checks, ‘onboarding,’ etc., all of which are costly and time-consuming. Workers can return to their jobs and immediately be productive.

Additionally, more than half of job losses have come from hospitality, accommodation, food services, retail trade and other service-sector jobs. Those who can work remotely – typically in high-skilled, higher-income jobs in tech, finance, management, professional services – saw a much smaller change to payrolls in March and April. The implication here, in my view, is that the majority of layoffs come from industries that could resume operations immediately when lockdowns and restrictions are lifted – which is beginning to happen now.

Jobs disappeared during the Great Depression because there was no demand, no capital, no functioning Federal Reserve or financial system. Companies had to permanently restructure – or declare bankruptcy – in droves. There was no safety net during the Great Depression.

Today, businesses are struggling in major ways, but they are also receiving financial support from the government with payroll loans that are in many cases forgivable, and workers across many industries are seeing close to full replacement of income from unemployment insurance under the CARES Act.⁵ This is not a Depression-like outcome.

2. Event-Driven Shock Versus a Structural/Financial Crisis

The collapse of the financial system was one of the major causes of the Great Depression. Today, banks are very well capitalized and the credit markets remain stable. Comparing the financial system during the Great Depression to the financial system today is essentially comparing night to day.

Because the causes of the Great Depression were structural, industrial production fell by more than half during the entirety of the 1930’s. Back then, industrial production was a critical component of the economy. Production trickled higher over a four-year stretch during the mid-1930’s, only to plummet sharply again in 1937-1938.⁶ Again, the Great Depression was a long, grinding decline. The current lapse in production and services is expected to last a few quarters – not years.

Historically, “event-driven” bear markets (which is how I would characterize the current downturn) have been shorter, less severe, and take less time to recover from than structural or cyclical downturns. I do not believe this time will be different.

Source: : Goldman Sachs⁷

3. Policy Mistakes Drove the Great Depression Deeper

Governments and central banks failed miserably in their response to the Great Depression, doing basically the opposite of what needed to be done.

In the midst of the 1930’s downturn, central banks tightened monetary policy in order to maintain the gold standard, resulting in severe deflation which raised the cost of debt and lowered real incomes. The U.S. government equally fumbled the response by putting austerity measures in place (cutting spending) just as the economy needed it most. The government also passed the Smoot-Hawley Tariff Act in 1930 in an effort to help domestic producers, but it only resulted in more pain due to the loss of global demand.

The policy response in the current crisis has drawn from lessons learned during the Great Depression, and the government and central bank are essentially doing the opposite of what they did during the Depression. The U.S. government has spent some $2.9 trillion in stimulus to boost the economy, and the Federal Reserve slashed rates to the zero bound in addition to offering basically unlimited liquidity to the capital markets.⁸ The difference in responses is night and day.

Bottom Line for Investors

I strongly believe the current recession will be shorter, less painful, and will inflict far less damage on households and businesses than the Great Depression. But that’s not to say it will be an easy and painless downturn. All recessions hurt the economy and society at-large, and it will take time to rebuild.

In my view, however, getting the economy back to a strong position may require about 15-18 months, versus the 10+ years that were needed to recover from the Depression. There’s no comparison, in my view.

Instead of letting fearful headlines influence your investment decisions, I recommend staying focused on the fundamentals and the long-term view during this recession. 

(source: Zacks Investment)

This could be the beginning of a tremendous oil rally.

According to https://oilprice.com/Energy/Oil-Prices/This-Could-Be-The-Beginning-Of-A-Tremendous-Oil-Rally.html , WTI will be back at $45-50 by end of the year.

Buy London Property

According to this article https://www.marketwatch.com/story/this-could-be-the-end-of-the-stock-market-as-we-know-it-but-thats-not-necessarily-a-bad-thing-strategist-suggests-2020-05-05 ,

buy real assets such as London property to prepare for the end of stocks.

Will this pan out?

Will a possible Aug crash predicted by this model trigger the next global stock crisis?

ECM

According to Martin Armstrong's Economic Confidence Model, the end for stock market bull run is coming.

Other notable events:
- a commodity bull market is being formed and will run into 2024
- demise of the West  (but not so soon, in 2032)
- rise of China (further out in 2037)

Chips are the place to be in a post-coronavirus world

Buy on any dips

Chips Ahoy!

https://www.theedgesingapore.com/issues/tech/chips-are-down-not-long

Goldman patiently bullish on oil

Goldman Sachs is patiently bullish on oil.

I am gonna ride the oil bull back up!

https://www.reuters.com/article/us-global-oil-research-goldman/goldman-patiently-bullish-on-oil-as-fundamentals-improve-idUSKBN22D61D

A Major Bull Run is Forming in Oil Markets

Came across this article.

Seems coherent with my current belief that oil markets are bottoming.

Read that there will be a commodity bull market which will last until 2024.

https://oilprice.com/Energy/Energy-General/A-Major-Bull-Run-Is-Forming-In-Oil-Markets.html