Politics: Elections Prompt Markets To Pause

With 2020 being a year of elections across the world culminating in the November 2020 U.S. general election, investors should consider that investment returns are likely to be muted until the electoral tea leaves are read. That said, Laidlaw expects positive investment returns will most likely be realized as a “relief rally” in the back half of 2020. Relative to the U.S. Presidential contest, while the expected candidates in the general election are Donald Trump (GOP) facing Michael Bloomberg (Democratic), it is important to note that there is high level of uncertainty as there are thoughts the Democratic Party at its July 2020 convention in Milwaukee, Wisconsin might have its first “brokered” convention in years. Meanwhile, impeachment, trade policy, technology sector regulation, health care reform, and Supreme Court vacancies are expected to result in a contentious campaign culminating in an election with high levels of voter turn-out. Interesting to note, 2020 will be the first U.S. election in which the “Baby Boomer” generation is no longer the majority of the electorate as “Millenials” move to the fore.

Macro-economy: Tariff Wars, “Brexit”, & Iran Are Wild Cards

The global macro-economy is likely subdued as major events such as the U.S.-China trade tariff confrontation and the distinct possibility of a hard “Brexit” by the U.K. from the E.U. remain unresolved. Note that the inclination of the current U.S. Administration to withdraw from long-standing multilateral agreements in favor of more inefficient bilateral trade arrangements is likely to leave open the possibility of increased trade tensions with the E.U., something that may result in ECB monetary policy moving away from continued experimentation with negative interest rates. In terms of exogenous shock, Laidlaw believes an increase in oil prices to the $75/barrel level is possible depending on OPEC production cut-backs and the possibility of conflict with Iran limiting Persian Gulf shipments through the Strait of Hormuz. With this as back-drop, GDP growth is expected as follows: U.S. +1.5%, E.U. +1.0%, and World +2.5%.

Markets: Equities +7% Due To Buybacks & “TINA”, Interest Rates Edge Lower 

The fixed income markets in 2019 called the tune as the shift in E.U. interest rates towards negative prompted the U.S. Federal Reserve to cut interest rates three times thereby supporting equities during a period when earnings contracted and capital investment spending stagnated under the uncertainty associated with the U.S.-China trade tariff confrontation. For 2020, Laidlaw has a 3,400 level target for the S&P500, a +7% total return from current levels. Equities benefit from a return to corporate earnings growth supporting stock buy-back activity coupled with low interest rates leaving investors in the position of “there is no alternative” to equities. While no further Fed interest cuts are thought to be in the offing, the estimated -0.6% impact to U.S. GDP growth from Boeing halting 737 Max production may change that view. The U.S. Treasury 10-year rate now at 1.92% is expected to contract to 1.25-1.50% over the course of 2020 as the global macro-economy slows.

Sectors: Tech Sees Regulation Risk Limit Potential, Election May Benefit Healthcare Prospects

While investors have built wealth since the 2009 Recession by taking an over-weight position in large-cap U.S. Tech, the increasing risk of greater regulation may serve to depress profit margins for names such as Alphabet and Facebook and in the process limit the sector’s appreciation potential. While the yield curve has steepened off the August 2019 lows, a development that has favored Financial sector shares, Laidlaw expects the macro-economy’s uncertainties to slow and eventually limit further curve steepening. Meanwhile, the possibility of “Amazonization” is rising in the Financial sector as Tech names are speculated to be considering potentially disruptive moves such Apple acquiring an asset manager. That said, Laidlaw views the Healthcare sector as offering an attractive combination of growth and valuation that has the potential to improve should the 2020 election better define its return potential.

David Garrity discusses cloud computing…

1) Bloomberg: https://www.bloomberg.com/news/videos/2019-10-28/growing-scrutiny-over-big-tech-video

2) Twitter: https://twitter.com/GVAResearch/status/1188839679501713408?s=20

3) Linkedin: https://www.linkedin.com/feed/update/urn:li:activity:6594605749333213184/

1) Tech – Cloud Computing Growth Remains Solid, But Quality Control Issues Threaten Tech Majors: One of the major shifts of interest to investors has been that of enterprise computing to “cloud” platforms. In this regard, there have been three major competitors – AMZN, GOOGL & MSFT. While GOOGL results won’t be out until after the close Mon 10/28, the indications from AMZN (AWS 3Q19 revenues $9bn, +34.7% year/year vs. +37% y/y in 2Q19) and MSFT (Commercial Cloud 3Q19 revenues $11.6bn, +36% y/y) indicate that while cloud adoption growth is decelerating from earlier levels, it still remains quite solid. With major growth areas such as cloud computing remaining robust, the near-term prospects for the tech sector remain positive. However, there are issues that should concern investors in terms of quality control that need to addressed as the major tech companies have become greater factors in consumer markets. For example, AMZN has been found to be delivering rotten food to consumers as it does not monitor its inventories to exclude items that have gone past their “sell by” dates. Also, AMZN has been using clothing production sources that have been shunned by others for unsafe work practices. As such, AMZN is likely to draw the attention of regulators. The company would do best to clean up its own act before others do it for them. Relative to FB (reports after the close Wed 10/30), CEO Mark Zuckerberg has been conducting speaking and testimony tour in Washington, DC in which he has tried to claim First Amendment rights for the company’s “disinformation for profit” business model. While that might accord well with the preferences of the current Administration, the political tide is clearly shifting in ways that will require FB and other social media companies to meet the content standards (e.g. factual truth) that other more traditional news and media organizations have upheld for years. Time to become accountable, Mr. Zuckerberg.

2) Markets – High Yield Spreads Do Not Call For Recession In 1H20: While indications are that the Administration’s self-inflicted trade war with China has brought sectors (i.e. manufacturing, agriculture) representing roughly 20% of the US economy into recession, it is useful to look to areas of the financial markets that historically served as harbingers of recession to see whether there will be follow-through to the broader economy. In this regard, a cursory examination of the interest rate spreads between BB and BBB corporate bonds is useful.

The data show the following:

A) The average BB/BBB spread from 1997 to now is +164 basis points. As with BBB spreads, these tend to widen ahead of recessions. From January to December 2000 they increased by +62 basis points. In 2007, BB/BBB spreads widened by +130 bp over the course of the year. Current BB/BBB spreads sit at +74 bp (BB: +223 bp, BBB: +149 bp). The conclusion is this marginal slice of the US corporate junk market shows little concern regarding an imminent recession.

B) BB spreads over BBB are well below long-run averages. The only times this spread shows similar tightness is March 2005 and the first half of 2007. As the chart clearly shows, there is no move higher for BB spreads underway right now. Not pictured but worth mentioning, the current +74 basis points is lower than October 1st (+81 bp) and flat versus a month ago (+73 bp).

Based on the above, corporate bond markets see little likelihood of a US recession or a material chance of weaker corporate cash flows in the near future. The bearish argument is that ultra-low interest rates have permanently skewed corporate bond payouts to the downside as asset owners reach for yield, thereby limiting their predictive power and setting up a pretty large cliff for these assets when recession does hit.

Separately, note recent WSJ article highlighting how ratings agencies have been giving remarkable leeway to BBB companies, a sentiment echoed by several investment banks of late. Rating agency credit rating laxity historically leads to financial crisis as it leads to risk being mispriced. Caveat emptor.

Watch David Garrity explain why Amazon may be at more antitrust risk than Facebook.

David Garrity, chief market strategist from Laidlaw and Company U.K and Dan Ives, managing director of equity research form Wedbush Securities, join CNBC’s “Closing Bell to give their take on which tech companies are most at risk from antitrust concerns. Click on the picture below to see the video…

David Garrity Discusses the Impact of the Trade War with China

Follow the links and read more below:

1) Bloomberg: https://www.bloomberg.com/news/audio/2019-05-28/we-are-in-a-technology-cold-war-laidlaw-s-garrity-radio

2) LinkedIn: https://www.linkedin.com/feed/update/urn:li:activity:6539488934144073729/

3) Twitter: https://twitter.com/GVAResearch/status/1133724593385029632

1) Tech – Whoever Builds The 5G Platform First Sets The Standards And Thus The Rules Of The Game: Published in 2015, the same year the PRC State Council laid out the “Made in China 2025” Plan (MIC2025) under which China would become a global powerhouse in ten high-tech fields from artificial intelligence (AI) to aviation, the novel “Ghost Fleet” depicts a possible global conflict scenario in which the United States (and by extension its allies) are defeated in large part due to the use of PRC-made components in its weapons systems that render them subject to enemy control and thus useless in wartime. While the novel depicted an update to the time-honored theme of the Trojan Horse in making the reader wary of accepting gifts from strangers, it did not anticipate the challenge now presented by the technology shift from 4G to 5G communications networks. In April 2019, the Defense Innovation Board, an advisory board of tech sector leaders to the U.S. Department of Defense, issued a report warning that the PRC is on track to pull off a “first-mover advantage” in the competition to dominate 5G mobile telecommunications. Note that 5G promises to revolutionize existing industries and invent entire new industries with data speeds of approximately 20x those of 4G. In the state-controlled economy that is the PRC, the primary competitor here is Huawei, the company that has become a focal point in the current U.S.-China trade war as the current U.S. administration is lobbying allies aggressively to keep Huawei equipment from being installed in their countries’ telecommunications infrastructure. However, “In public and private statements, American intelligence officials and telecommunications executives and experts have begun to concede that the United States will be operating in a world where Huawei and other Chinese telecom companies most likely control 40 to 60 percent of the networks over which businesses, diplomats, spies and citizens do business.” With the prospect of a PRC 5G “first-mover” advantage, the U.S. will be operating in a world where it is not setting the standards, a world where networks are possibly subject to PRC state control and thus compromised, or “dirty networks.”

2) Tech – China Needs To Push Hard To Establish Regional Hegemony As Demographics Work Against It: While the rapacious nature of PRC-led misappropriation of technology intellectual property is well-known as the country seeks to attain its MIC2025 goals, one perhaps under-appreciated factor prompting the PRC’s need for speed is that fact that its demographic profile is in many ways reminiscent of that Japan faced in the 1980s in which the country was clearly seen to face a rapid increase in its elderly population, something that has clearly occurred. According to researcher China Power, the percentage of Chinese above the retirement age is expected to reach 39 percent of the population by 2050. At that time, China’s dependency ratio (the number of people below 15 and above 65 divided by the total working population) is projected to increase to 69.7 percent, up from 36.6 percent in 2015. Add to this negative development the PRC’s gender imbalance in which the country has 70mm more men than women and we are left with the sense that the PRC has internal pressures to establish dominance regionally while it has a demographic “window of opportunity,” something that raises the odds of conflict intensifying over the next 5-10 years.

3) Tech – A War By Any Other Name Is Still Conflict All The Same As PRC Conducts An Unchecked Cyber War: Apologies to Shakespeare, but one may say that all is fair in love and war and so it is in the ongoing and unceasing cyberwar that the PRC is waging against the US and its allies. Granted the PRC is far from alone in this new front of global conflict, but it is among the most persistent and the most pernicious of state actors seeking to penetrate critical infrastructure and to steal intellectual property so as to further its ambitions under MIC2025. While cyberwar is a silent war, it is war nonetheless and there should be no illusions otherwise.

Please find disclosures below.

Disclosure – Ownership:

Personal: BTCS
Family: AAPL, INTC, MSFT, PYPL
Firm: AAPL, INTC, MSFT

David Garrity on Big Tech Regulation Risk & Implications

Follow the links and read more below:

1) Bloomberg: https://www.bloomberg.com/news/audio/2019-05-28/we-are-in-a-technology-cold-war-laidlaw-s-garrity-radio

2) LinkedIn: https://www.linkedin.com/feed/update/urn:li:activity:6539488934144073729/

3) Twitter: https://twitter.com/GVAResearch/status/1133724593385029632

1) Tech – “Big Tech” Breakup Proposals on 2020 U.S. Presidential Election Radar: Legislators’ interest in investigating and potentially regulating the tech sector has been building since the 2016 U.S. general elections. Concrete proposals have been coming forward since Senator Elizabeth Warren (Democrat, MA) on Fri 3/18/19 as part of her 2020 Presidential election bid put forth a proposal that would result in substantial controls and possible break-up being imposed on tech companies with revenues in excess of $25bn with a specific focus on Alphabet, Amazon and Facebook.

In the proposal, Senator Warren picked up on the September 2017 Yale Law Review article by Lina Khan (“Amazon’s Antitrust Paradox”) which argued that “Amazon is amassing structural power that lets it exert increasing control over many parts of the economy.” The concept of “structural power” breaks with more traditional tests of anti-competitive behavior such as the unilateral ability to set prices. “Structural power” goes beyond pricing power to touch on a company’s ability to determine the market access of other companies, much as railroads controlled market access in the last half of the 19th Century. In Khan’s view, “the thousands of retailers and independent businesses that must ride Amazon’s rails to reach market are increasingly dependent on their biggest competitor.”

Senator Warren has moved to translate the concept of “structural power” into an anti-monopoly legislative and regulatory program. Namely, companies with over $25 billion in revenue that offer the public an online marketplace/exchange/platform for connecting third parties would be designated a “platform utility”. Accordingly, such companies would not be able to participate in the platform they operate (e.g. Amazon would have to stop selling its own products on its website). If elected President, Warren would also appoint regulators committed to reviewing and potentially reversing previous acquisitions (e.g. Amazon/Whole Foods, Facebook/Instagram, Google/Waze).

2) Tech – Anti-Monopoly Policy Is Competition Policy Which Needs To Be Set In Global Context: U.S. Anti-monopoly policy was last substantially updated in 1949, a point in time where policy makers were primarily concerned with the domestic U.S. economy as the global economy was only just beginning to recover from the devastation of WWII. Now, with a global economy no longer as dominated by the U.S. and one challenged increasingly by the government-led technology sector’s development in the PRC, policy makers need to think in terms of a larger global stage.

As the PRC’s “Made In China 2025” plan clearly spells out, it is China’s intent in concert with Chinese technology companies (e.g. Alibaba, Baidu, Tencent) to dominate critical emerging technologies such as AI, autonomous vehicles & others. In this sense, anti-monopoly policy if it results in U.S. technology companies not having sufficient economic scale to support their own emerging technology development efforts may have significant national security ramifications. In essence, in the 21st Century context, technology development has become like diplomacy before it, “the continuation of war by other means.” Consequently, Senator Warren’s proposal while a positive development in moving forward the idea of increased regulatory oversight for the technology sector needs to consider the current and likely future realities against which it would be implemented.

3) Tech – Not All Tech Companies Created Equal, Some Names Merit Greater Oversight And Possible Breakup: It is difficult to say that social media technology companies such as Facebook and Twitter are critical to the future national security of the US, especially given the substantial lapse in necessary vigilance around the 2016 Presidential election, but nevertheless should for these very reasons be subject to increased regulatory oversight. To this end it is our view that following a thorough in-depth examination from economic and national security perspectives that current anti-monopoly policy be developed and then applied to the technology sector.