I’m writing to you from New York following a week of meetings with companies, investment banks, analysts, strategists, fund managers and executives.
The timing of the trip coincided with a bout of heavy volatility breaking out on Wall Street, largely as a result of the trade dispute. It’s helpful to be on the ground to understand what is driving such volatility and whether it provides another buying opportunity in leading US equities or it’s something more serious.
The US has the largest, deepest and most important equity markets, supported by the incredible wealth that has been created over the past century. I was reminded that US investors have a clear home bias for where they allocate their capital. The pro-business Trump Administration and a market friendly Federal Reserve add to reasons why the outlook for US equities is constructively optimistic. These arguments are tough to dispute at the current juncture. By all accounts, the US economy is still expanding, with full employment, rising wages and increased capital spending by corporations. Very few experts I met with expected a recession in the near term and most subscribed to a form of “goldilocks “ view of moderate growth and sustained low inflation for the next 12 months.
Beyond this supportive backdrop, I have heard positive messages from corporates who are acting on the underlying momentum of the economy and investing. Whilst we are always monitoring risk factors and there has been nervousness around the trade disputes, I expect the moderate growth and low inflationary period to continue to be supportive for risk assets. Some are even suggesting that the Federal Reserve may cut interest rates in the second half of 2019, as inflation remains contained.
A significant focus area for markets is the US-China trade dispute, which for some, has been an excuse to take “risk off the table” and lock in profits, following a strong performance in 2019. However, the seasoned corporates and investors I met believe that any weakness presents an opportunity to selectively add to key US equities that are not directly impacted by the tariffs. One stock that doesn’t fall into that category however is Apple (APPL.US), as caution remains around its exposure to a potential escalation in the trade war. Remember the iPhone is “designed in California” but made in China and has so far been exempt from US tariffs. If the US were to implement a 25% tax on the remaining $267 billion+ of goods exported from China to the US, there would be considerable ramifications across Apple’s operations and supply chain. According to Morgan Stanley, one-third of Apple’s total cost of goods sold are imported from China, adding a 25% tax would see the cost of an iPhone XS increase by ~$160 (if passed on to the consumer). If Apple were to absorb the cost of tariffs, FY20 EPS would be impacted by 23%. This is assuming no changes to the current supply chain, and we note that Apple, along with key manufacturers, is looking at diversifying away from China.
An additional negative headwind for Apple yesterday was a US Supreme Court ruling that may allow an antitrust lawsuit against its App Store to proceed, potentially challenging the current business model. The ruling may mean consumers (as well as app developers) could sue Apple under antitrust laws related to the monopolisation of the iPhone App ecosystem by the App Store. While this issue is likely to be long and drawn out, it could potentially be significant as the App Store is Apple’s largest standalone service, accounting for 35% of services revenue. Whilst various scenarios are possible, this development adds to uncertainty surrounding Apple and its future earnings growth.
Concerns around Apple’s earnings and those of other select US corporates, as a result of a possible escalation in the trade war, were a key negative influence on US equity indices over the past week. The other clear sentiment problem was the weak listing of Uber (UBER.US). An underwater IPO is a short-term problem but not one that is insurmountable in the medium term. Remember, Facebook halved from its IPO price but is now 5x that price and 10x its lowest share price after listing. The soft IPOs from Uber and smaller ride-sharing competitor Lyft have dented confidence in higher PE tech in the very short term, but I must say that both were a touch unlucky in their listing timing in terms of a bout of volatility breaking out just as they listed.
Despite short-term market gyrations, the research trip provided cautious optimism of how segments of the AIM portfolio are positioned, in leading US businesses. I was on the trading floor of Morgan Stanley as the Dow Jones fell 600 points. Morgan Stanley is the number 1 US equities house and the price action was orderly, with most of the selling coming from index futures. While the red ink was eye catching, in the last hour of trading, some stock specific buy orders started coming in. It was good to be right in the action on a big day on Wall St, watching and learning how these big market days unfold from US experts. It’s clear to me that US investors will favour US equities over everything else. When the trading dust settles, US equities tend to recover more quickly than other regions. I think this will continue to be the case and believe that trading dips such as the current one will be bought. US companies such as Microsoft, Amazon, Alphabet, Visa, and MasterCard for example, will likely be rewarded.
My trip to New York gave me greater confidence in the US economy, US earnings growth and the market structure. However, I suspect sentiment from the US towards China and China facing investments to remain negative. This includes commodities, resources and the Australian dollar.
As I board the iconic Flying Kangaroo for the flight home and reflect on what I have learnt in the past week, I remain convicted on owning some of the best businesses in the world. The short-term noise may continue, and we will be using this as an opportunity to add tactically. I thought it was important to share these insights following a significant few days on Wall Street.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
