Global Weekly: What happened with tech?

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Those investors who happened to have invested in Facebook, Apple, Amazon, Netflix and Alphabet (Google) -the so-called FAANG stocks- at the beginning of this year, may have sabered their magnum champagne too early, when they saw the returns at the end of the third quarter (average +42%). By now they may wish they had opened their prosecco instead, because since the last quarterly meeting of the investment club the return of these stocks on average was -22%. What happened?

To explain this, we introduce the ratio between the average valuation relative to earnings growth. At the end of September, these stocks had a ratio of 1.2. History shows that an average of 1 is roughly normal. Depending on the sector it may be a little more (growth stocks) or less (value stocks).

It is our belief that the market has started to put the growth aspect of the FAANG stocks into question. The current projected earnings growth (analysts’ consensus) for Apple in 2019 is just 13%, for Alphabet it is 4% and for Facebook, it is even less, 3%. The valuation would therefore become too high relative to the earnings growth.

The correction has brought the combined FAANG stock’s ratio to 1. Since most of these stocks are traded in ETFs, the correction has dragged the whole market down. In combination with the Brexit, the trade conflict, Italy’s debt problem and fear about growth prospects for the US and China in 2019, the year-end market rally may just not be a done deal.

Bonds: Not there yet

Global risk sentiment continues to be weak, since various risks in advanced economies are obviously not priced in sufficiently, such as the outcome of the US midterm elections, the political turbulence in Italy and contracting growth dynamics in the eurozone.

The latter two, Italy and the eurozone, are worrying, as investors still remember the political and economic chaos before ECB President Mario Draghi came up with his famous „whatever it takes“ speech. Both US Treasuries and German Bund yields saw support from the current weaker risk environment and returned to the lower trading line of around 3.05% and slightly below 40 basis points (bp).

During the upcoming G20 summit next week, US President Donald Trump and President of China Xi Jingping will allegedly meet to resolve the current trade dispute by defining a clear framework. This could quickly lift core yields in the US and eurozone back to the upper trading range of 3.25% (for the 10 years US Treasuries) and 50 bp (for German Bunds).

Nevertheless, we do not think that the trade tensions will disappear immediately, but rather slow down gradually. This means that tariffs will keep impacting financing costs of US companies. This effect could already be seen in rising credit spreads. This might get even worse when the conflict escalates further. US Treasury yields should be kept within the abovementioned range, by the release of the October Fed minutes and next week’s speeches of both US Fed Chair Jay Powell and Vice Chair Richard Clarida, who recently had somewhat opposing views concerning the path of the US monetary policy.

The European Commission (EC) is expected to issue its final opinion on Italy’s revised budget. The revision was more a cosmetic act rather than a substantial one. We expect the EC to start the process of opening an excessive deficit procedure (EDP) against the country relatively quickly. This can cause renewed pressure on Italian bonds, when it is formally launched. As such steps are likely to materialize first in the second half of 2019, we do not rule out that Italy could fade as a major market topic over the next couple of weeks. In the meantime, the Italian Treasury needs to attract new buyers, as supply is set to increase next year due to a larger budget deficit.

Emerging markets suffered from lower bond prices and various headwinds, while advanced economies benefitted from a strong credit performance. Valuations, however, became too expensive and hard to explain with the actual fundamentals. But even so, emerging economies remained robust and we currently still see value in emerging markets bonds.