Category Archives: General

Risk-O-Meter

As is now customary ahead of Davos week, the latest World Economic Forum report on global risks was released and the usual graphic of the top 5 global risks in terms of likelihood and impact are reproduced below. Environmental risks and technology risks again dominate the likelihood list which is indicative of the current consensus. As this post highlights, the likelihood of irreversible climate change within the next 10 to 20 years is the short, medium and long-term issue of our times.

Although the report does state that “geopolitical and geo-economic tensions are rising among the world’s major powers” and that these “tensions represent the most urgent global risks at present”, I was somewhat surprised to see that geopolitical risk did not make the top 5 likelihood list this year. Despite the current market (wishful in my view) thinking of a kick the can down the road fudge outcome, Brexit in 2019 may result in a constitutional crisis in the UK or the possibility of a large portion of the population being alienated by a possible rushed outcome this Spring (e.g. hard Brexit or permanent custom union). His Orangeness and his ability to flame division, whether internally in the US after a bad Mueller report or against China to deflect from his pitiful negotiating style, are ever present possibilities for 2019 (if not hopefully remote ones). Although maybe somewhat alarmist, I can’t but help worry that his reign may end with some form of violent turmoil, he will not go quietly!

As an aside, the wonderful TV show “Brexit: The Uncivil War” from the UK’s Channel 4, which I think is on Netflix now, does raise the issue of how democracies will operate in a world where all sides can use technology to manipulate a (potentially decisive) disengaged minority to the political extremes. If the long-term success of democracy is dependent upon compromise, then we may be in trouble. Pundits say the implications of Brexit politics is a break from the traditional left/right or conservative/liberal divide, into a much more complex mixture of differing tribes. In fact, I would highly recommend this video from Dominic Cummings, the main subject of the show, who ably explains the parameters of the new political landscape (if you don’t have the time to watch it all, watch a few minutes after the 15-minute mark on how they did it).

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One other item that caught my attention in the WEF report, in section 6 called Open Secrets, was the assertion that when “the huge resources being devoted to quantum research lead to large-scale quantum computing, many of the tools that form the basis of current digital cryptography will be rendered obsolete”. The article further asserts that “public key algorithms, in particular, will be effortlessly crackable” and, under certain scenarios, “a collapse of cryptography would take with it much of the scaffolding of digital life”. Do I hear a new arms race approaching? The report predicts “as the prospect of quantum code-breaking looms closer, a transition to new alternatives—such as lattice-based and hashbased cryptography—will gather pace” although “some may even revert to low-tech solutions, taking sensitive information offline and relying on in-person exchanges”. Imagine having to rely on people meeting other people to get things done……..unthinkable!

A naughty or nice 2019?

They say if you keep making the same prediction, at some stage it will come true. Well, my 2018 post a year ago on the return of volatility eventually proved prescient (I made the same prediction for 2017!). Besides the equity markets (multiple posts with the latest one here), the non-company specific topics covered in this blog in 2018 ranged from the telecom sector (here), insurance (here, here, and here), climate change (here and here), to my own favourite posts on artificial intelligence (here, here and here).

The most popular post (by far thanks to a repost by InsuranceLinked)) this year was on the Lloyds’ of London market (here) and I again undertake to try to post more on insurance specific topics in 2019. My company specific posts in 2018 centered on CenturyLink (CTL), Apple (AAPL), PaddyPowerBetfair (PPB.L), and Nvidia (NVDA). Given that I am now on the side-lines on all these names, except CTL, until their operating results justify my estimate of fair value and the market direction is clearer, I hope to widen the range of firms I will post on in 2019, time permitting. Although this blog is primarily a means of trying to clarify my own thoughts on various topics by means of a public diary of sorts, it is gratifying to see that I got the highest number of views and visitors in 2018. I am most grateful to you, dear reader, for that.

In terms of predictions for the 2019 equity markets, the graph below shows the latest targets from market analysts. Given the volatility in Q4 2018, it is unsurprising that the range of estimates for 2019 is wider than previously. At the beginning of 2018, the consensus EPS estimate for the S&P500 was $146.00 with an average multiple just below 20. Current 2018 estimates of $157.00 resulted in a multiple of 16 for the year end S&P500 number. The drop from 20 to 16 illustrates the level of uncertainty in the current market

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For 2019, the consensus EPS estimate is (currently) $171.00 with an average 2019 year-end target of 2,900 implying a 17 multiple. Given that this EPS estimate of 9% growth includes sectors such as energy with an assumed healthy 10% EPS growth projection despite the oil price drop, it’s probable that this EPS estimate will come down during the upcoming earnings season as firms err on the conservative side for their 2019 projections.

The bears point to building pressures on top-line growth and on record profit margins. The golden boy of the moment, Michael Wilson of Morgan Stanley, calls the current 2019 EPS estimates “lofty”. The bulls point to the newly established (as of last Friday) Powell Put and the likely resolution of the US-China trade spat (because both sides need it). I am still dubious on a significant or timely relaxation of global quantitative tightening and don’t feel particularly inclined to bet money on the Orange One’s negotiating prowess with China. My guess is the Chinese will give enough for a fudge but not enough to satisfy Trump’s narcissistic need (and political need?) for a visible outright victory. The NAFTA negotiations and his stance on the Wall show outcomes bear little relation to the rhetoric of the man. These issues will be the story of 2019. Plus Brexit of course (or as I suspect the lack thereof).

Until we get further insight from the Q4 earnings calls, my current base assumption of 4% EPS growth to $164 with a multiple of 15 to 16 implies the S&P500 will be range bound around current levels of 2,400 – 2,600. Hopefully with less big moves up or down!

Historically, a non-recessionary bear market lasts on average 7 months according to Ed Clissold of Ned Davis Research (see their 2019 report here). According to Bank of America, since 1950 the S&P 500 has endured 11 retreats of 12% or more in prolonged bull markets with these corrections lasting 8 months on average. The exhibit below suggests that such corrections only take 5 months to recover peak to trough.

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To get a feel for the possible direction of the S&P500 over 2019, I looked at the historical path of the index over 300 trading days after a peak for 4 non-recessionary and 4 recessionary periods (remember recessions are usually declared after they have begun), as below.

Note: These graphs have been subsequently updated for the S&P500 close to the 18th January 2019. 

click to enlarges&p500 q42018 drop compared to 4 nonrecession drops in 1962 1987 1998 & 2015 updated

 

click to enlarges&p500 q42018 drop compared to 4 recession drops in 1957 1974 1990 & 2000 updated

 

I will leave it to you, dear reader, to decide which path represents the most likely one for 2019. It is interesting that the 1957 track most closely matches the moves to date  (Ed: as per the date of the post, obviously not after that date!) but history rarely exactly rhymes. I have no idea whether 2019 will be naughty or nice for equity investors. I can predict with 100% certainty that it will not be dull….

Given that Brightwater’s pure Alpha fund has reportingly returned an impressive 14.6% for 2018 net of fees, I will leave the last word to Ray Dalio, who has featured regularly in this blog in 2018, as per his recent article (which I highly recommend):

Typically at this phase of the short-term debt cycle (which is where we are now), the prices of the hottest stocks and other equity-like assets that do well when growth is strong (e.g., private equity and real estate) decline and corporate credit spreads and credit risks start to rise. Typically, that happens in the areas that have had the biggest debt growth, especially if that happens in the largely unregulated shadow banking system (i.e., the non-bank lending system). In the last cycle, it was in the mortgage debt market. In this cycle, it has been in corporate and government debt markets.

When the cracks start to appear, both those problems that one can anticipate and those that one can’t start to appear, so it is especially important to identify them quickly and stay one step ahead of them.

So, it appears to me that we are in the late stages of both the short-term and long-term debt cycles. In other words, a) we are in the late-cycle phase of the short-term debt cycle when profit and earnings growth are still strong and the tightening of credit is causing asset prices to decline, and b) we are in the late-cycle phase of the long-term debt cycle when asset prices and economies are sensitive to tightenings and when central banks don’t have much power to ease credit.

A very happy and healthy 2019 to all.

The Queen is Dead

Long live the queen……Aretha will never die.

There are many many songs that sound-tracked our lives and will continue to do so for generations. Rock Steady is one on my favourites for its pure raw funkiness… she knew how to sock it to us!

Aretha Franklin 1942-2018 RIP.

click to enlargeAretha Franklin Rock Steady quote

 

Generational Music

People of my generation, like those before us no doubt, like to moan on about the quality of modern music. When I look back at the diversity of the music from the 1980’s that I grew up listening to, I cannot but help feel that this generation is missing out.

As it happens, the 2018 Global Music Report from IFPI indicated that the multi-year decline in global music revenues has bottomed out. The 2017 industry revenues grew by 8% over 2016, with streaming revenues up 41%. This represents three consecutive years of growth after many years of decline. The music sector is one of the earliest examples of the awesome creative destructive ability of the digital revolution, as the graph below shows.

click to enlargeGlobal Music Industry Revenues 1972 to 2020 April 2018

The physical, digital and streaming revenues are obvious (e.g. CDs & vinyl, downloads & streaming). Performance rights includes the revenues generated by the use of recorded music by broadcasters and public venues. Synchronisation revenues include the revenues from the use of music in advertising, film, games and television programmes.

As a regular theme of this blog is the impact of the digital revolution under way on so many industries and the need for sectors to adapt through digital transformation of their business models, the graph above is both thought provoking and scary.

Listening to the investment pitch by Spotify this week over the future of the sector, I can’t but help think that the democratisation and disintermediation promised by the internet age has resulted, for the music sector at least, in dominant players dictating homogeneous tastes and culture. The death of individualism seems to be the result, at least until this or future generations get fed up with it.

Dastardly Data Breaches

Like many people, I am concerned about security and privacy online but, until now, I have been too lazy in regularly changing and varying passwords or in using tools such as two-step or two-factor verification. Then I came across this article which contained this paragraph:

How might a digital EPA function? Well, it could do some of the work that individuals do today. For example, the website of Australian security expert Troy Hunt, haveibeenpwned.com (“pwned” is how elite, or “l33t,” hackers, or “hax0rs,” spell “owned”), keeps track of nearly 5 billion hacked accounts. You give it your email, and it tells you if you’ve been found in a data breach. A federal agency could and should do that work, not just one very smart Australian—and it could do even better, because it would have a framework for legally exploring, copying, and dealing with illegally obtained information.

The haveibeenpwned website allows you to check if your email has been subjected to a data breach. As far as I can assess, the website is legit (it passed by antivirus and nothing suspicious came on a Mr Google search about the website or Troy Hunt) though I cannot verify that as a fact.

Below are the number of data breach incidents from hacking by year the incidents were made public, as publicly disclosed and monitored by Privacy Rights Clearinghouse. 2016 includes high profile incidents like Yahoo and LinkedIn. Obviously, there is likely to be many many more incidents which haven’t been found out or publicly disclosed.

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Oh, and by the way, it looks like two-step or two-factor verification is deeply flawed also, as per this article. Nonetheless, I am told it’s better to have it than not.