Sharpening Pencils On Global Valuations: “Cheap For A Reason”


Whenever I hear the phrase “sharpening a pencil” to do some detailed analytical work, I think about the Eberhard Faber Blackwing 602 – the most famous pencil in the world. Developed during the Great Depression as a premium writing instrument, the Blackwing became the preferred daily instrument for everyone from John Steinbeck to Quincy Jones, Truman Capote to Stephen Sondheim. Production stopped in 1998, and vintage examples go on eBay for +$30 apiece. If you want to delve into pencil-geekdom, there is a link at the end of this section with more information.

Today we’ll sharpen only the proverbial pencil on the question of global equity valuations. After last year’s parlous performance in both Emerging Markets (down 19%) and EAFE (non-US developed equities, down 15%), how do the world’s stock markets shape up in terms of relative valuation to US equities?

Three points on this topic:

#1. The rest of the world’s equities markets do, in fact, trade at a significant discount to US stocks just now. The data from MSCI (link here):

  • US stocks trade for 15.4x forward earnings; non-US stocks trade for 12.0x the same measure.
  • Breaking down the rest-of-world valuations, EAFE (developed Europe, Asia, Far East) stocks trade for 12.4x forward earnings. Within that region, Europe (11.8x) and Japan (11.7x) show similar forward valuations and are slightly cheaper than the rest of the EAFE index.
  • Emerging Markets trade for 11.0x forward earnings, but the regional variations are wider than EAFE: Asia (11.3x), Eastern Europe (6.3x), and Latin America (12.6x).

Summary: non-US stocks trade for a 19% (EAFE) to 29% (Emerging Markets) discount to US equities.

#2. The disparity between US and non-US stocks has been growing since the Great Financial Crisis.

  • Both US and non-US equities bottomed at 14x forward earnings in 2009.
  • The valuation gap between these two asset classes peaked in late 2017/early 2018 at just over 4 points. At that time “rest-of-world” equities traded for 14x forward earnings while US stocks sported an 18.5x multiple.
  • That gap has narrowed to 3.4 PE points now.

Summary: the discounts for EAFE and Emerging Market equities are nothing new. They have been in place for almost 10 years to varying degrees. The best thing one can say is that they have narrowed (modestly) over the past year.

#3. Fundamentals like sector/country allocations drive long-term valuations, and these explain both historical differences and are the cornerstone issue to assessing potential future returns.

  • In both Emerging Markets and EAFE indices, Financials hold the largest allocations at 24% and 19% respectively. In the S&P 500, the group only holds a 14% weight. 

    Importantly, Financials tend to have lower valuations regardless of geography so larger weights will tend to reduce PE ratios, as the data in point #1 clearly shows.

  • Technology weightings tell a similar story in reverse, because in the US the S&P is 20% Tech (and more like 30% if you count FB, GOOG, and AMZN). Compare that to the 14% weighting for Tech in Emerging Markets and just 6% in the EAFE Index. 

    As with Financials, these weightings skew headline valuation measures like forward PE ratios, with Tech regularly enjoying higher PE ratios regardless of geography.

  • Country weightings also play a role. 

    Half of the EAFE index is Japan (11.7x forward earnings PE), UK (11.7x) and France (12.1x), three countries with distinct demographic and economic challenges that likely merit their low valuations. 

    The Emerging Markets index is 54% China (10.4x forward PE), South Korea (8.8x) and Taiwan (13.2x). Considering the role current US/China trade negotiations play across these countries’ future economic growth, those lower-than-US valuations make sense to us.

The bottom line to all this: “cheap for a reason” comes to mind when discussing the relative undervaluation of non-US stocks. The valuation gap has been growing for years, driven by sector and geographic fundamentals. It is neither an anomaly nor an investment positive that rest-of-world stocks have lower valuations.

Just like those $30 Blackwings on eBay, US stocks are expensive for a reason.

via ZeroHedge News Tyler Durden

Tim Cook Wields Apple’s App-Store Power: Blocks Google Developers, Gets Personal With Zuckerberg

A day after taking similar action against Facebook, Apple has unleashed developer-hell on Google by pulling important app-development tools from the internet giant for breaking the iPhone-maker’s rules.

Bloomberg reports that Google employees can’t access test versions of iPhone apps they’re making, or use internal apps related to transportation scheduling and food, the people said. Security alerts are limited too, one of the people said. They asked not to be identified discussing private matters.

“We’re working with Apple to fix a temporary disruption to some of our corporate iOS apps, which we expect will be resolved soon,” a spokeswoman at Alphabet Inc.’s Google said in a statement. Apple restored Facebook’s privileges on Thursday.

This comes less than 24 hours after Facebook’s app development was hobbled in a similar way in a sign that many say suggest Apple is wielding power as operator of the most-lucrative U.S. app store to push its approach to user privacy.

Apple offers an “enterprise certificate” that helps some companies work on iPhone apps without going through the usual app review process. Facebook and Google used this to collect data on user activity for internal research.

Bloomberg notes that when this was reported earlier this week by TechCrunch, both companies stopped the activity. Apple said Facebook had broken its rules and pulled the social-media company’s certificate until Thursday. It’s now punishing Google, too.

And specifically, Google and Facebook rely on the enterprise certificate to test the iPhone versions of the apps they’re making. Without this option, some of the companies’ most important app-development work is disrupted.

“They have no problem flexing their power with us,” Paulo Andrade, a software developer who builds apps for Apple operating systems,said.

“It’s a good sign. It’s Apple drawing the line with these big companies.”

But, there may be more to this sudden show of force by Tim Cook (who has rarely missed an opportunity in the past year to hit Facebook about its privacy issues. As NBC News reports, some observers of the two companies believe the fight has become personal between Zuckerberg, the 34-year-old from New York who founded Facebook, and Cook, 58, an Alabama native who was a largely anonymous tech executive until he took over Apple in 2011.

“The heart of this is ego. These two hate each other,” said Scott Galloway, a New York University marketing professor and author of “The Four,” a book about the dominance of Apple, Facebook, Amazon and Google.

At its core, NBC points out that the disagreement speaks to a growing philosophical rift in the tech industry between companies that make money off personal data, and those that do not. Apple is on one side (companies should not exchange privacy for services), while Facebook is on the other ( data-targeted ads are a small price to pay for connecting the world).

“We’ve got one cowboy on the platform side, and another cowboy on the service side, standing off and pointing guns at each other.”

Consumers expect tech companies to get along, said Rene Ritchie, a senior analyst at Mobile Nations, a media company that focuses on the tech industry.

“You count on everybody to be on their best behavior,” he said.

It seems – as times get tougher for Tim Cook that flexes his platform’s muscles is they way to demonstrate his company’s worth (oh and signal some virtue too) – but as Scott Galloway so eloquently concludes:

“There was Ali-Frazier. Now there’s nerd vs. nerd,” he said.

via ZeroHedge News Tyler Durden

An Important Wrinkle In Chinese Bank Hoarding

Authored by Jeffrey Snider via Alhambra Investment Partners,

In theory, it is always so simple. For China, it was intended that RRR cuts are stimulus. By allowing banks to use more of the reserves they’ve built up over the years it is meant to add to overall interbank liquidity. From there, banks flush with RMB supported by robust RMB money markets will lend and undertake more direct economic transactions.

Voila, stimulus.

The theory gets complicated by a very different kind of reality, one which pressures RMB markets from two sides. The first is the direct result of the overriding issue. The eurodollar market malfunctions, forcing China to deal with a “dollar” shortage by having its central bank (and others) intervene out of its own stockpile of FX reserves. Simple accounting, the PBOC’s asset side shrinks which must be met by the same on the money side.

So, RRR cuts already begin from inside a domestic monetary hole. To even get to the position of adding liquidity, banks have to mobilize more of their reserves than the central bank has pulled back in its own.

The second liquidity problem is just that: banks have to mobilize meaning actually use more of their reserves. The Economics textbook simply says that if given the opportunity no bank will refuse the license. Policy says, bank books do. In theory.

In practice, banks have to operate in the real world. If the PBOC is in a situation already where it feels compelled to respond to less-than-ideal effective conditions via an RRR cut perhaps it really isn’t a conducive time for banks to be so generous? Reserve operations of this type don’t usually happen unless things are already dicey, a factor bank managers are going to be pretty well aware.

Therefore, RRR cuts may not lead to the flood of non-public liquidity the theory assigns. Chinese banks, especially the biggest institutions, may opt to hoard that liquidity instead. If they do, then RRR measures cannot be stimulus especially having begun at first in the central bank hole.

When Chinese banks hoard, obviously nothing good will result. The illiquidity is not contained within China’s borders, either, as these kinds of financial irregularities flow into the real Chinese economy and are then transported to the rest of the world (further amplified by more negative feedbacks in the eurodollar system).

This was Euro$ #3’s devastating global downturn story of 2015 and early 2016.

We are on the lookout for evidence of China bank hoarding so as to figure a possible repeat here well within Euro$ #4. From the very first we see just that sort of difficulty in real-time market prices, in this case SHIBOR and other RMB money rates. The correlation is ridiculously obvious; RRR cuts have unleashed volatility and instability rather than what would look like monetary stimulus.

Chinese banking statistics back up the negative association – with an added wrinkle (more on that below).

Since the first 2018 RRR cut back in April last year, the big banks aren’t really lending more in the unsecured interbank markets. They are, however, borrowing more from them; a lot more. The difference is almost surely the reason for harmful volatility in domestic money.

The biggest banks are draining liquidity (net) from unsecured RMB rather than contributing more to them. The relationship with volatility in SHIBOR is established.

The primary reason is equally evident: this is the same period in which bank reserves have been declining. The PBOC’s eurodollar squeeze leading to the systemic limit on its money (liability) side is being echoed by the majority of the domestic banking sector.

Without a liquidity cushion either in that money remainder (growing bank reserves) or in terms of robust central bank RMB expansion at its liquidity windows (such as MLF) there just isn’t any appetite for banks to add anything to these crucial interbank spaces.

The wrinkle in all this is repo. We know why the biggest institutions are borrowing more unsecured – they are barely borrowing (sources) in repo! Depending more and more on unsecured interbank transactions instead of the repo market, you can start to appreciate why these particular banks are perhaps more than a little skittish no matter what policy the PBOC might undertake.

If conditions worsen in China, more economic slowing and therefore higher perceived overall risk, being reliant in greater proportion on unsecured markets for so much marginal funding isn’t an ideal liquidity situation. To put it mildly.

The question is why they aren’t in repo. It may be that China’s authorities told us last month when they began to really champion the issuance of perpetual bonds to be used along with the central bank bill swap. It certainly seems to fall in line with what we see here; if the big banks are in a collateral crunch, why not just create collateral out of thin air (first the perpetual and then the swap into usable repo instruments).

I wrote about this just a few days ago:

To aid the situation on both counts, the PBOC last month hit upon a two-part scheme. The central bank would encourage the use of perpetual bonds that meet the definitions for being included as bank capital. Any Chinese bank that issues these securities will be able to boost their ratios, making it seem like it has more loss absorption capacity (which, in theory, it would).

The second part is this bill swap program. Perpetual bonds are illiquid therefore unacceptable in repo…

To circumvent these technical deficiencies, the PBOC will allow banks who issue perpetual bonds to swap them with its own holdings of central government debt bills which they can then use either in private repo or even in targeted MLF at that particular monetary policy window.

This data can’t, unfortunately, tell us why a collateral crunch seems to have developed. Such a negative outcome would further explain the hoarding of liquidity along with the greater desperation on the part of monetary authorities – escalating official responses that don’t seem to get anywhere. China’s money hole across a couple dimensions seems to be bigger than we already think.

It is, as Abraham Lincoln once said, the equivalent of shoveling fleas across a barnyard; not half of them get there. “There” being RMB liquidity. This isn’t monetary stimulus indicated here, hoarding is instead, a huge and growing monetary deficiency which seems to be squeezing the Chinese economy. Again.

via ZeroHedge News Tyler Durden

Biggest Fentanyl Bust in History: Border Patrol Seizes Enough Drugs “To Kill 57 Million People”

Just days after we reported that the Massachusetts Attorney General is suing the makers of OxyContin, the deadly nature of America’s opioid crisis has again reared its ugly head: US border patrol agents just made the largest Fentanyl bust in the country’s history, confirming that this nationwide epidemic is worse than ever.

On his show this week, Tucker Carlson reported: “Well, the U.S. border patrol has made the biggest fentanyl bust in history. An enormous amount, enough fentanyl to kill—they estimate—57 million people. That’s more than the combined population of the states of Illinois, New York and Pennsylvania. It’s a lot.”

Reporter Hillary Vaughn on Fox News broke the story, stating: “We got our hands on an internal memo from U.S. Customs and Border Patrol that details this bust. The biggest fentanyl seizure in U.S. history. According to the memo, four days ago in Nogales, Arizona, at the port of entry, CBP officers stopped a tractor-trailer crossing the U.S.-Mexico border into the U.S. with enough fentanyl to kill 57 million people.”

The Fentanyl shipment – which was found under the floor of the trailer – consisted of a whopping 114 kgs of the drug – compare this to the just 2mg that is considered to be a fatal dose. Agents also seized 179 kg of methamphetamine. The total seizure was said to have a street value of $102 million.

The smuggler, a Mexican national, was a member of the DHS trusted traveler program (FAST) and was arrested at the border. 

This comes just days after the Massachusetts attorney general declared that the family behind the drug Oxycontin is responsible for the opioid epidemic ravaging the United States. Purdue Pharma and eight members of the Sackler family who own the company, are being accused of personally starting the opioid crisis by deceptively selling Oxycontin.

According to CBS News, MA attorney general Maura Healey alleges the Sackler family hired “hundreds of workers to carry out their wishes.” Those wishes included pushing doctors to get “more patients on opioids, at higher doses, for longer, than ever before” all while paying “themselves billions of dollars.” In her lawsuit, Healey names eight members of the family that own Purdue Pharma, alleging they “micromanaged” a “deceptive sales campaign.” 

In the conclusion to the complaint, Healey said the Sackler family used the power at their disposal to engineer an opioid crisis.

You can watch the entire Tucker Carlson segment on the bust here:

via ZeroHedge News Tyler Durden