E Markets: Extensions

Buying more time may not change the outcome but it always reduces stress and fear that a deadline leads to sloppy work and missed opportunities. Buying more of a trend has the opposite effect as a linear move becomes parabolic. The contrast of what more time means dominates the week ahead. The extension of US/China trade talks and the removal of any magic around March 1 maybe seen as a benefit to investors given the laser focus on the US/China talks and the building hopes that a deal is near. Sequencing events suggest, more talks now mean a mid-March meeting with Trump/Xi and a April 1 deal. That drives risk-on. Against this, you have the US markets underperforming last week as EM and Asia shine with hopes that global trade and growth return. The annual investment letter from Buffet and the Berkshire Hathaway results may be a counter to this given his America investment theme and $25bn 4Q loss. Some of the blame for this was leveled on Kraft Heinz (KHC) given its SEC investigation. In the week ahead, the focus is likely to remain on trade, Brexit, FOMC policy and the heavy economic data releases from US 4Q GDP to ISM, to German jobs and China PMI. The theme of US growth and policy divergence versus the rest of the world was 2018’s story and yet many continue to see this holding using the USD and S&P500 as the barometers. US shares are up 11% year-to-date and the broad Russell 2000 index has had its best weekly winning streak since 1996. But so too has emerging markets with the focus on China recovery and value driving.

Buffets letter is taken as a guide map for value investors into 2019. He wrote that investors should continue betting on the American economy because Berkshire has prospered by doing so, but that they shouldn't forget about the rest of the world. "There are also many other countries around the world that have bright futures. About that, we should rejoice: Americans will be both more prosperous and safer if all nations thrive," Buffett wrote. "At Berkshire, we hope to invest significant sums across borders." Berkshire continues to hold roughly $130 billion in cash and short-term investments because he hasn't found any reasonably-priced acquisitions in recent years, so he'll likely continue investing more in stocks. "Prices are sky-high for businesses possessing decent long-term prospects," he wrote.

The profit margin focus in US shares is significant and contradictory as FactSet highlights in its weekly insight report. “For the first quarter, the S&P 500 is projected to report a year-over-year decline in earnings of 2.7%, but year-over-year growth in revenues of 5.2%. Given the dichotomy in growth between earnings and revenues, there are concerns in the market about net profit margins for S&P 500 companies in the first quarter. The estimated net profit margin for the S&P 500 for Q1 2019 is 10.8%. If 10.8% is the actual net profit margin for the quarter, it will mark the first year-over-year decline in the net profit margin for the index since Q4 2016. It will also mark the lowest net profit margin reported by the index since Q4 2017.”

Question for the Week AheadWhat matters most in the week ahead? The next week brings a host of economic data, political decisions and important meetings. The battle of politics is every present in the market headlines whether its Brexit, EU immigration and nationalism, US immigration and the 2020 Presidential race, or China and its middle-income trap. The evolution of the debate in markets has shifted from the end of history to a battle between capitalism and socialism again.

Korea maybe the first focus, with the Trump/Kim summit grabbing the headlines, but the Bank of Korea rate decision and the early February data from Korea leading the economic reports on the present cost of the trade disruption and China slowdown. The role of China in the debate connects with the expectation being that North Korea denuclearization rests on a good outcome for US/China trade talks. Xi has a card to play and won’t give up leverage without something from Trump. The politics of South Korea are in play as well as the growth hit of 4Q continuing in 1Q will make the pressure to solve North Korea issues that much more intense. The WSJ article last week on the Moon push for higher minimum wage and its effect on growth stands out. Its minimum wage will rise by 10.9% this year, after a 16.4% increase last year. At 8,350 Korean won per hour ($7.44), the rate is now higher than the U.S. federal minimum wage, even though the country’s gross domestic product per capita is around half the U.S.’s. Even before these increases, the Korean minimum wage was equivalent to 53% of the country’s median wage in 2017—on par with the U.K.’s and higher than Japan’s.

Brexit remains a key focus. The ECB highlighted the effects of Brexit on growth last week. The May progress report next week will clearly be in play for markets as it will add to the political risks ahead. The splintering off of 7 Labour MPs last week brought some hopes that a Corbyn government wasn’t imminent. The Tory support for May’s plans remains in doubt and the lack of any consensus over how to divorce from the EU leaves many expectations a delay first. GBP gains in the last week will be watched against the reality of the deadline in March.

EU growth and politics. The drum beats warning about the EU Parliamentary elections in May continues across markets. Since the last EU election in 2014, Britain has voted to leave the EU and Italy and Austria have government coalitions that include the far right. Over a dozen EU nations have fragile minority governments and Poland has turned as hostile toward Brussels as Hungary. The role of growth in fixing anti-EU nationalist politics will be clear and the Draghi comments highlighted over the weekend the pressures on EU institutions and Brexit/anti-EU debates. The PMI reports for Europe next week will be watched accordingly. 

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