## On Changing Your Tune While Live On Air  ##

In previous notes I’ve talked about how scary debt should be to investors. I’ve spoken about zombie companies just getting by paying their low interest rates with profits.
I’ve talked about what happens when those companies have their interest rates increased and it’s not good.

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I’ve also spoken about companies not investing profits in themselves or their industries but rather opting to keep shareholders happy with buybacks and dividends or spending money on takeovers and acquisitions.
It’s all very late on the market cycle clock when these things start to happen.
I’ve also mentioned the deal machine revving its engines this year with the highest number of deals by valuation since just before the GFC.

Now, consider that we’re in the 10th year of this run in the US noting total returns year-on-year have six months to maintain its course & break the record for consecutive “up years” set in the 90s.

Not stretched at all….

 

Now, please have a look at this chart which I first saw last week and saw again referenced yesterday by the Financial Times in a note about how “the bull market in highly leveraged companies could be coming to an end.”
Scary headline but definitely worth the read if you pay the FT fee to read it.

Crunch time nears for highly leveraged US companies

The blue line is S&P 500 debt to EBITDA ratio & is turning downish, red line is relative performance & is uppish. 

The chart above is simple even by Goldman Sachs’ usually confusing terms. Put simply, the GS strategy team used an old ‘credit-quality test’ by Edward Altman, a finance professor from the 60s. The test showed that since the start of 2017 shares of well-capitalised companies (using Altman’s method) have fared better than their opposite, leveraged, counterparts.

Easy & not something new: Lower debt & higher cashflow will outperform in a rising rate environment. Easy. 

So sell growth stocks? Maybe not. Funnily enough one of the companies in the S&P 500 with the strongest balance sheet is: Facebook.

Facebook. Seriously. Who I derided when it went IPO all those years ago because 12% of their revenues came from the makers of Farmville!!
Things change and when they change so I do (or however the saying goes)
The Global Macro Fund holds a small amount of Facebook and has done right through the privacy scandals, although I will not lie my finger hovered over the sell button more than once.

We’ve seen this story before though and while the US & global economy are strong there’s no need to be a seller, definitely not a shorter of markets. It’s a bull market when stocks keep going up in the face of obvious future issues.

Economically it appears that we’re doing fine globally so why pick a chair before the music stops?

Well today the music may have possibly stopped.

 

I was scheduled to be on Bloomberg radio this morning and as I was preparing, about half an hour before going to air, this drops like a sack of bad potatoes.

So it hit the wires that Trump has called for an extra $200bn of tariffs at 10% TO BE IDENTIFIED on top of the $50bn at 25% everyone was talking about last week.
Recap:
US brought in tariffs of $50bn, saying any retaliation to the US tariffs by China would spark a retaliation by the US.

China retaliated with its own 25% tariffs set to go into effect in July on $34bn worth of US goods.

So the US has retaliated this morning.

I scored very highly in 3 Unit Modern History and whilst I’m no expert this is how wars start.
We just need a couple of uni students to shoot an Archduke and we’re on!

Seriously though, this looks and feels much like the beginnings of a Trade War and I hope I’m wrong.

As everyone knows I’m very much a “play the man & not the ball” type of person when it comes to global politics, especially now we’re dealing with Trump who as all personality and not much else.

I’m calming myself with the knowledge that the last year and a half has mostly consisted of sabre-rattling and continued economic growth. This is nothing more than Trump asking for a list.
It’s a play in the deal.

We hope.

So having to prep for an entirely new conversation in just a few minutes and I’m on air literally as Chinese markets are opening and an hour into our Tuesday session in Australia.
In the space between “introducing James Whelan from VFS Group” to “thanks for joining us James” my story went from “we’re strongly in the green here, it looks like the market knows this is a game” to “it’s gonna be a long night guys!”
Markets were starting to reverse & it was going to be one of those days.

The ASX 200 Index: That last candle where we touched fresh recent highs than were sold off completely is a pretty substantial reversal.
Courtesy Interactive Brokers

Australian markets towards EOFY
Locally we’re staring down the barrel of a lower AUD which won’t do much for commodities but should help exporters. Let’s see how the dust settles on this trade war before doing anything too hasty.

Wow CBA feature prominently don’t they?

We’ve had a plenty of Royal Commission into our banks and a weakening housing market and now we’re potentially about to find ourselves in the middle a trade war involving our biggest trading partners.
Our dollar will most likely keep declining which continues to benefit our long USD position held by the Global Macro Fund.

We head quickly into the end of the month, quarter and financial year and are wary of a very interesting phenomenon in which certain stocks are dropped in time for tax loss selling and certain stocks are bought because you have to have them:

  1. In portfolios and,
  2. They’re already in portfolios and need to be higher before EOFY.

It’s cynical but I think our local banks are in categories a & b for now. I currently (for now) am “OK” with Australian banks and (provided markets aren’t wiped out in the next few days) am happy to pick up a few if they keep rallying.

All the best & stay safe out there,

James Whelan & the VFS Global Macro Fund
Level 30 Australia Square, 264 George Street, Sydney NSW 2000
t +1300 220 360  | m +61 407 958 036 |  www.vfsgroup.com.au/gmf

 


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