After a 1000 point midweek Dow rally, the US stock market was slammed again by 567 Dow points on Friday after President Trump announced $100 billion in additional tariffs on China and the March payroll growth number was a dismal 103,000 relative to the Wall Street consensus of 180,000. The financial markets fear that the tensions between the US and China will escalate into a trade war that could well trigger a global recession. China has promised to “resolutely counterattack” against Trump’s tariffs. The American President’s game of chicken over trade policy has clearly backfired with the People’s Republic. Trade concerns hits companies with China exposure like Boeing, Caterpillar and Apple but also financials, since the shares of US money centre and regional banks fall when the safe haven bid on hostile trade rhetoric flattens the US Treasury bond yield curve.
The March payroll data and moderate wage inflation data reduces the risk of aggressive Fed tightening, at least in the short run. The US stock market’s valuation has now compressed from 18 to 16.7 times earnings. Yet the US tax cuts will boost first quarter corporate earnings growth, possibly to as high as 18% annualised rate. A Wharton study has, however, calculated that a trade war with China will wipe out all the gains from Trump’s fiscal stimulus. Mark Zuckerberg’s testimony to Congress next week and President Trump’s anti-Amazon tweets still haunt tech shares.
Fear has now replaced greed as the dominant sentiment on Wall Street, with the Chicago Volatility Index up 90% in 2018. Exporter dominated stock market like Germany, Sweden, South Korea, Japan and Taiwan fall in unison to trade fears, given the sheer scale and importance of the Chinese markets to them. In a world of economic interdependence, there is no place to hide.
The risk of a US-China trade war justifiably unnerve investors, even though I am amazed that US soybeans, corn, Kansas red wheat and cattle futures prices are up for 2018, not in free fall. Commodities, unlike global equities, obviously do not price in the reality of a trade war. Italy is also a source of risk for global markets given the failure of any political party to form a coalition government in Rome, a 130% debt/GDP ratio, three failed banks, a 35% youth unemployment rate and zero economic growth in a generation. No wonder 50% of the Italian electorate voted for populist parties. There is also a non-trivial risk that the Republicans could be routed in the midterm Congressional elections, thus guaranteeing legislative deadlock in Washington for the rest of Trump’s term. As the Federal Reserve shrinks its $4.5 trillion balance sheet, the risk of a policy error by Chairman Powell on the path to monetary normalisation is also all too real.
The ten year US Treasury note yield has risen from 2.40% to 2.80% in 2018 alone. Inflation expectations have also risen, due to a white hot US labour market and a potential rise in Chinese import prices due to the tariffs. This means a bond market meltdown is inevitable.
As I search for mispriced asset classes, emerging market currencies stand out. Monetary tightening in Washington and Frankfurt makes emerging markets vulnerable to a trade war. As volatility has risen in 2018, emerging markets have remained relatively unscathed. The biggest risk lies in the Thai baht, South African rand, Taiwan dollar, Pakistani rupee.
Brazil’s former President Lula de Silva has been sentenced to 12 years in jail for corruption and money laundering. This ends his 2018 Presidential ambitions. Even though the real and the Bovespa rose once the Supreme Court’s decision was announced, I would avoid Brazil assets for now. Lula led the polls and it is likely a far left populist candidate will emerge to challenge President soybeans in October. The Sao Paulo soybeans will go ballistic at such a prospect, given the Bovespa’s dramatic valuation rerating in the past two years. The Brazilian real is a short at 3.25 for a 3.70 target. The real had underperformed in 2017 on lack of progress on pension reform and the lack of a credible pro-growth candidate for president. This is a compelling argument to short the Bovespa at 85000, albeit with a tight stop. This lodestar of global emerging markets now flashes a SOS to me, thanks to the three toxic T’s of Wall Street – Trump, Tariffs, and Tech!
Macro Ideas – Istanbul’s luxury property in a bear market
I have visited Istanbul a dozen times since the late 1990’s, captivated by the exquisite atmospherics of the ancient Byzantine/Ottoman city on the Bosphorus Straits. Istanbul, with 15 million inhabitants, the Turkish Republic’s financial and banking capital, was a magnet for foreign investors in the past decade. Saudi Arabian, Kuwaiti, Russian, Iraqi and German investors led a tsunami of foreign money investing in new condos and even villas in the Beyoğlu, Levent, Bebek, Nişantaşı districts of Istanbul, triggering a construction boom that spelled speculative disaster to me. This is exactly what happened. In 2014, oil prices crashed, ending the Gulf petrocurrency bonanza. In 2015, a Turkish F-16 shot down a Russian warplane in the skies above the Syrian border and triggered a diplomatic crisis in Ankara-Kremlin relations. In 2016, an abortive coup d’état horrified all of us Istanbulphiles with its scenes of violence on the Ataturk bridge. In 2017, Turkey’s constitutional referendum and rifts with the West caused economic and political turmoil. I remember buying Turkish lira at 1.20 to bid for the Turkish Telekom IPO. The Turkish lira now trades at 3.96 as I write, the worst performing emerging market currency of 2018.
While Istanbul property tripled in the past decade, most Gulf investors were aghast to see the Turkish lira lose 70% of its exchange value against the US dollar. Russian investors fared even worse, as Putin’s annexation of Crimea and military intervention to save the Assad regime in Syria has led to a crisis in Turkish-Russian relations that reverts to historical patterns during the reigns of the Romanov tsars and Ottoman sultans. The Russian ambassador to Ankara was gunned down by an assassin at an art gallery. The unsettled politics of post-referendum, Turkey have also unnerved foreign investors. When I hear Erdogan accuse his central bank chief of “treason” if he dared to raise interest rates or fulminate against bankers as “evil forces in the economy”, I know the Turkish lira will continue to depreciate against the US dollar. Yet this is an absolute disaster for the stratospheric prices in Turkey’s luxury property development projects.
There is no doubt that Turkey’s expanding middle class, access to home mortgages, migration from Anatolia and the Black Sea/Aegean coastal towns and the lowest ever interest rates will anchor Istanbul property values in the affordable segment. Yet the Turkish lira is one of the most volatile currencies on the planet and it is difficult to hedge currency, let alone geopolitical risk, on the Bosphorus. Terrorist bombings by Daesh and the PKK secessionists in Istanbul have also hit prime property values. There is no sense investing in a Trump Tower in Şişli at a time when the Turkish military confronts a US allied Kurdish militia in the Syrian border town of Afrin.
The exceptional political instability seen in Turkey since General Kenan Evren’s military dictatorship in the 1980’s means its middle class prefers investing in homes and gold rather than traditional financial assets such as stocks and bonds. Yet this has also meant that 50% of new houses built in Istanbul have been designated for investment, not for owners to live in. I avoid investing in any property market that is dependent on foreign money, not local demand, as it is invariably prone to speculative boom bust cycles.
Istanbul will remain one of the world’s fastest growing property markets, despite the current fall in the prices of its prime developments. It is also crucial for Gulf investors to remember that high risk currencies like the Turkish lira (or the Malaysian ringgit, Pakistani and Indian rupees) can and do lose 50% of their value against the US dollar in a decade. As long as Turkey’s current account deficit, the largest in Europe, is financed by offshore hot money, the lira will remain one of the most volatile currencies in the world. The rift between President Erdogan and the Ankara central bank does not exactly reinforce investor confidence. I also worried about the political (and financial) cost of 3 million Syrian refugees, Kurdish secessionist violence in eastern Anatolia and the inflation’s rise to 12% its highest pre-Lehman levels. The AKP’s draconian response to the failed coup has seen 150,000 Turks either arrested or losing their jobs. Wealthy Turks are major investors in Portugal’s golden visa program. None of this is positive for the long term outlook of Istanbul property prices.
Market View – Making money on Wall Street’s media mergers & acquisitions
Merger mania in global media has been intense since 2017, with Walt Disney’s $66 billion bid for 21st Century Fox’s television and movie studio assets, Comcast’s rival bid for British satellite television platform Sky (39% owned by Rupert Murdoch’s Fox media conglomerate). The Justice Department lawsuit against the ATT and Time Warner merger and CBS’s lowball takeover bid for Viacom. Content spending worldwide is estimated at $90 billion in 2018 by RBC Capital Markets, making it imperative for media firms to create global economies of scale. This is all the more true since digital platforms like Netflix and streaming technologies create new paradigms of competition, risks and monetisation. It is now entirely possible that media conglomerates like Disney, Comcast and ATT-Time Warner will target acquisitions for pure play content companies worldwide (Lionsgate?).
Comcast’s $31 billion bid for Britain’s Sky now raises the prospect of a bidding war with Walt Disney/Fox. Shares of both Disney and Comcast have fallen 12% since US cable TV operator (and owner of MSNBC, CNBC and Universal Studios) made its takeover bid for Sky on February 27. Of course, the real problem for Comcast is that Fox has a 39% stake in Sky. The fact that Sky trades in London at a premium to Comcast’s original offer means that the financial markets expect a bidding war or even a Comcast bid for Fox’s Hollywood move/studio television assets in the US pledged in its Disney merger agreement. This is the reason the Sky bid has proved so catastrophic for Comcast’s share price on Wall Street. This is not surprising since Sky, at 12 times EBITDA, would be hugely dilutive for Comcast. This dilution is all the more ominous since cord-cutting is a major media trend that will hit Comcast more than Disney, despite the Magic Kingdom’s ownership of ESPN and now Fox’s cable networks (e.g. National Geographic). Comcast trades at 7.4 times projected EBITDA, a valuation range reminiscent of wireless telecoms like Verizon and At&T. Of course, the real reason I am loath to own Comcast is that the Roberts clan controls 33% in supervoting stock despite owning a mere 1% of the company, making a mockery of the concept of shareholder value optimisation. When founders treat a public company like a family fiefdom (Murdoch? Hearst? Conrad Black? Lord Rothemere?), it is usually best to avoid the stock, period.
Traditional media companies naturally face an existential threat from Google, Facebook, Netflix and even Amazon.com. These are all global media colossi, unlike Comcast, which derives only 9% of its revenues from outside the US.
It is increasingly likely that AT&T will win the Justice Department’s antitrust lawsuit against its merger bid with Time Warner in Washington. AT&T’s cash and securities offer is worth $104 a share, above Time Warner (symbol TWX)’s share price $96 as I write. The AT&T-Time Warner merger deal could close by July 2018. This means merger arbitrageurs, the proverbial Wall Street arbs, will accumulate Time Warner shares, but the wide deal spread exists because even the Street’s top arbs do not have the capital to harpoon a $74 billion megacap media whale.
There is a political dimension to this merger since the Trump White House has accused CNN, a division of Time Warner, as selling “fake news”. So, the Justice Department will want to demonstrate its political independence and not block this vertical merger at a time when Apple and Amazon have entered the media business. This media deal will close. Warner Brothers is Hollywood’s second most profitable movie studio after Walt Disney and with pay TV colossus HBO, contributes 50% of its parent’s profits. Time Warner can well rise above $110 a share just on earnings growth alone.
Disney has now offered to buy all of Sky News to help British regulators approve Fox’s 11.7 billion bid for its parent Sky PLC. This move will help Fox foil Comcast’s takeover bid for the UK pay-TV broadcaster. So, Disney ownership of Sky News would ease regulatory concerns about monopoly power. Rupert Murdoch is political poison in Westminster due to outrage over the 2011 tabloid phone hacking scandal. After all, News Corp also owns the Times, the Sunday Times and the Sun tabloid in London. Yet a bidding ware for Sky between Fox and Comcast remains the most likely scenario to me. Viacom will resist CBS’s bid since the board believes it undervalues Showtime and CEO Bob Bakish is not guaranteed the number two position in the merged business.
