More air in the bubble
After Fed’s dovish turn, overvalued stocks continue to lead benchmarks up
News media Tuesday focused on continuing US-China trade talks. With North Korea’s leader Kim Il Jung visiting in China, there is some speculation that China is angling for a comprehensive deal with the Trump Administration, involving trade as well as nuclear issues on the Korean peninsula. That’s a more benign reading than my Monday morning take on the trade talks.
But that’s not what’s moving markets.
Financial conditions eased in the US after the Federal Reserve backed away from its indicated course of monetary tightening and stock prices rose in response.
That’s pretty much the whole story of equity markets during the past week. US central bankers are a cowardly ilk. They complain about overvalued assets and prospective market bubbles, but when the time comes to let blood, they drop the scalpel and run. That doesn’t exactly inspire confidence in equity markets, especially because equity markets are led by the bubbliest valuations.
The S&P 100 Index gained 2.3% over the past week. The top performer was Celgene (+36%), a dog of a stock that bounced when Bristol Meyers bid for it at a huge premium to market, losing 8% of its own stock valuation as a result.
Second best was Netflix, up 20% in the week and now trading at 111 times trailing earnings, a fanciful valuation for a cash-burning movie studio. And third was General Electric, which did a dead cat bounce on a prospective asset sale. The biggest contributor to market valuation was Amazon, which I continue to think is worth $1,200 on a good day vs. today’s price of $1,650.
The world economy continues to shrink. Germany’s industrial production is down 4.7% year on year, in part because of crazy regulation on auto emissions and in part because world trade and capital investment are falling in the midst of a trade war. As I reported yesterday, both China and the US are showing mediocre industrial numbers and substantially better service numbers.
There’s limited risk of a US recession. Consumer credit continued to grow modestly through November, with a 4% year-on-year gain, the Federal Reserve reported today. Combined with a weak capital investment picture and a battered outlook for housing, consumption growth should keep US GDP at around a 2% growth rate for the time being.
The question for the market leaders remains: Where are profits going to come from?
The likes of Netflix and Amazon don’t show profits, just growth. But Amazon needs to show nearly 30% annual sales growth to persuade investors that its stock is worth buying at present levels, and it can’t keep growth at that level. Analysts are projecting 25% revenue growth for Netflix in 2019, which is dicey given that a half dozen major competitors are offering the same service and the market is pretty much saturated.
The semiconductor industry got a kick in the teeth from the Trump trade war (US components go into Chinese products that are assembled in China and sold in the US). Long term, US semiconductor designers will contend with a domestic Chinese industry that has mobilized to make China independent of US components, following the ZTE export ban of early 2018. AMD is the top performer in the S&P 100 during the past 12 months with a 68% gain. But Huawei announced yesterday a new line of workstation chips that compete head-to-head with AMD or Nvidia.
Boeing is another market leader that faces new competition from China, in the form of China’s C919 medium-rate passenger jet, which already has 1,000 pre-orders.
It remains to be seen whether the US stock market will be sustained by earnings growth, rather than merely relieved by the temporary cheapening of leverage.