“A lot happens in our everyday life, but it always happens within the same routine, and more than anything else it has changed my perspective of time. For, while previously I saw time as a stretch of terrain that had to be covered, with the future as a distant prospect, hopefully a bright one, and never boring at any rate, now it is interwoven with our life here and in a totally different way. Were I to portray this with a visual image it would have to be that of a boat in a lock: life is slowly and ineluctably raised by time seeping in from all sides. Apart from the details, everything is always the same. And with every passing day the desire grows for the moment when life will reach the top, for the moment when the sluice gates open and life finally moves on.” – Karl Ove Knausgård, Norwegian novelist
There are a lot of interesting and market moving developments that have either transpired or come to light over the course of the last week or so. This week we take a break from taking a deep(ish)-dive into a given theme and instead parse through some of these developments.
US Market Breadth
As US markets have recovered and moved within a whisker of the year-to-date highs recorded in January, we have witnessed a growing chorus of criticism on the robustness of the recent rally. One of the more common criticisms is how only a handful of stocks – namely Facebook, Amazon, Netflix, Google, Microsoft and Salesforce.com – are responsible for the positive returns of the S&P500 Index year to date and were it not for these stocks, the market would be in the red.
To that we counter with two pieces of evidence.
The equally weighted index of the constituents of the S&P500 Index, as of Wednesday’s close, is 2.3 per cent from its January highs.
The equally weighted index of the constituents of the Nasdaq 100 Index, as of Wednesday’s close, is above its January highs.
There have been and continue to be plenty of opportunities to outperform the broad market indices without the need to invest in the FAANG or other large cap tech stocks. You just need to do the work.
There are of course other criticisms including valuations, such as price-to-sales and price-to-earnings multiples, and the near record high net profit margins being achieved by companies, which critics argue should all mean revert over time and said reversion should lead to a sharp drop stock prices.
With respect to valuations, we counter with two arguments: (1) valuations can mean revert by either prices dropping or sales / earnings increasing, as the quarterly results of the current reporting season have demonstrated, valuations in many instances are adjusting on higher sales and / or earnings; and (2) rich valuations are not in and of themselves a precursor for market corrections, rich valuations are a necessary condition for equity market corrections but not a concurrent one.
Turning to record high profit margins as a bearish argument against owning US stocks, we counter that such arguments do not adjust for the change in the composition of major US equity market indices. Once the S&P500 Index, for example, is adjusted for the changes in sector weights, profit margins do not appear to be anywhere near as high as they appear to be without adjusting the index for changes in sector allocations. This is because the current heavyweights of the index, namely tech and healthcare stocks, tend to generate much higher margins than businesses in other sectors that dominated index historically.
The changes in the composition of the index also go some way to explaining the high level of the price-to-sales ratio the market is trading at – at risk of stating the obvious, higher margin businesses capture much more of their sales as profits than do lower margin businesses, and thus high margin businesses are bound to trade at higher multiples of sales than do low margin businesses.
Is Amazon the biggest threat to Google’s dominance in search-driven advertising?
Quoting Brian Olsavsky, Amazon’s chief financial officer, from the company’s quarterly earnings update:
“A big contributor to the quarter and the last few quarters obviously has been strong growth in our highest profitability businesses and also advertising.”
The CFO further added that Amazon is working to automate tasks for advertisers and to help media buyers measure the results.
Last quarter, Amazon’s revenue from the advertising sales category and some other items grew 132 per cent year-over-year to US dollars 2.2 billion. Quarterly revenue of over US dollars 2 billion is not to be scoffed at. More importantly, this revenue is coming straight out of Google’s share of the advertising market.
The appeal of advertising on Amazon for advertisers is obvious: customers searching on Amazon are already there with the intent of buying something. With Amazon controlling close to 45 per cent of total online sales in the US and perpetually increasing its product offering, it becomes progressively more convenient for online shoppers to begin their product searches with Amazon and not Google. If the propensity of consumers to being their product searches with Amazon over Google continues to increase, the proclivity of advertisers to spend their dollars on Amazon over Google is also likely to follow suit.
How Google responds to this challenge is something we await with much intrigue.
We expect Amazon to be the first company to achieve a trillion dollar market capitalisation.
Japanese Government Bonds
Global bond markets have been roiled by speculation that the Bank of Japan (BoJ) is considering tweaking its policy stance and could scale back its stimulus programme. Yields on 10-year Japanese government hit a fresh twelve-month high on Thursday, forcing the BoJ’s in making a rare intervention in the bond market to push yields on the 10-year government bonds back below 10 basis points.
In practical terms, the BoJ currently guides the yields on 10 year government bonds to be within the range of 0 to 11 basis points. The official directive, however, only states that “The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent.”
We are of the opinion that the BoJ will take steps to widen the tight range of 0 to 11 basis points on 10-year government bonds associated with the ‘around zero’ directive. The objective of said widening being to allow Japanese banks to have more influence on 10-year rates and to steepen the curve ever so slightly to enable them to make their lending activities profitable.
Qualcomm / NXP Semiconductor
The two-year saga of Qualcomm’s attempted acquisition of Dutch chipmaker NXP Semiconductors came to an abrupt end after the deal failed to receive final approval from Chinese regulators ahead of the expiration of the companies’ agreement on Wednesday night. Had the transaction gone through, it would have been the semiconductor industry’s largest ever acquisition.
Unquestionably, the Qualcomm-NXP deal is collateral damage in the political game between Beijing and Washington and can be seen as retaliation for President Donald Trump’s tariffs on Chinese imports.
After Congress, earlier this month, decided against re-imposing a seven-year ban on ZTE, the Chinese telecommunications equipment and systems company, from buying equipment in the US market — a move that would have effectively put the Chinese firm out of business, it was widely expected that China would have cleared the Qualcomm-NXP deal quid pro quo. By effectively ending the Qualcomm-NXP deal, however, the Chinese leadership is essentially adopting an extremely hawkish strategy toward the US.
We believe the Chinese move to end the Qualcomm-NXP deal is a significant escalation of trade-related tensions with the US, and see it is as weakening the position of dovish officials on both sides: in this case, Steve Mnuchin for the US and Liu He for the Chinese. This should only further complicate US-China trade related negotiations.
Trump-Juncker Meeting and the Prospect of Improved US-EU Trade Relations
In a joint announcement after meetings in Washington on Wednesday, President Donald Trump and the EU’s Jean-Claude Juncker declared a truce on trade-related tensions with the aim of eliminating all tariffs, trade barriers and subsidies related to non-auto industrial goods.
The rosiest outcome, from the perspective of the global economy, following this joint declaration is that President Trump seeks to settle the US trade-related tensions with the EU, Canada and Mexico, and instead focuses his energy on China – something Peter Navarro, Robert Lighthizer and other security and trade hawks in the administration have probably wanted all along.
If the rosy scenario does indeed materialise then the EU is likely to join in on US efforts to back against China’s efforts to move up the industrial value, discriminatory tariffs and abuse of intellectual property rights. The US-China trade-related tensions would escalate and Qualcomm’s failed acquisition of NXP would not be the last casualty in this spat. Every major US and Chinese company and asset would become fair game and everyone loses – China more than the US we suspect.
Earlier this year, President Trump announced broad based tariffs on steel and aluminium imports. Following the announcement, however, there were clear signals given by his administration that many of the US’s allies would be granted exemptions. Given that this not only did not happen but that the tariffs were fully imposed on US allies, we assign a very low probability to the rosy scenario materialising.
Instead, we expect Mr Trump to keep upping the ante on trade, irrespective of the counterparty, right up until the mid-term elections. And only expect a coherent strategy on trade to materialise after the elections.
Uranium: Extension of Cameco’s Facility Shutdowns
In November last year, Cameco Corporation, the world’s largest publicly traded uranium mining company, announced that it was temporarily suspending production at two of its northern Saskatchewan facilities – Key Lake and McArthur River – for a period of ten months. The decision was driven by the oversupply of uranium and low market prices that have persisted ever since Japan shut down its nuclear reactors following the radiation leaks at Tokyo Electric Power’s Fukushima Daiichi nuclear plant in 2011.
Taking Cameco’s lead, Kazatomprom – Kazakhstan’s state-owned uranium mining company and the world’s largest natural uranium producer – announced in December last year that it would cut production by 20 per cent, representing 7.5 per cent of total global supply, over the next three years.
The impact of these two announcements was to send both uranium spot prices and share prices of listed uranium miners sharply higher. The euphoria did not last long, however. Spot prices gradually drifted lower, falling from just under US dollars 25 per pound at the start of the year to under US dollars 21 per pound by late April. And the stock prices of many of the uranium miners fell below where they traded prior to Cameco’s announcement in November.
As spot prices fell, expectations that Cameco would extend the shutdown of its two Saskatchewan facilities started to grow. And Cameco has not disappointed, announcing on Wednesday after market, along with its quarterly results, that it would be suspending production at the two mines ‘indefinitely’ and does not plan to resume production at the site until the company can commit its ‘production under long-term contracts that provide an acceptable rate of return’.
The corollary of the extended suspension is that Cameco will be a buyer of up to 14 million pounds of uranium from the spot market (or otherwise) over the next 18 months to fulfil its commitments under on-going contracts.
Prior to their quarterly earnings call on Thursday morning, Cameco’s shares in pre-market trading were marked at 7 plus per cent below their closing price on Wednesday evening. Cameco shares closed up 3.4 per cent by end of trading on Thursday and spot uranium prices jumped 6.2 per cent to year-to-date highs at US dollars 25.65 per pound.
The malaise in the uranium sector may turn out to be much worse than Cameco’s management anticipating and the rally in the spot could well prove to be fleeting once again. If, however, uranium spot prices can push above US dollar 26.25 per pound, the highs recorded in 2017, they have significant room to run much higher.
For now we remain long select uranium miners as well as commodity pure play Uranium Participation Corporation $URPTF.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.