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Has the Fed Rewritten the Laws of Investing?

The only way to argue that stocks aren’t wildly expensive is to say that something fundamental has changed about the market environment.

Thanks to the Federal Reserve, such a change might actually have occurred but investors could pay a heavy price if they turn out to be wrong.

The S&P 500 trades at 22 times analysts’ expected earnings—its most expensive level since the dot-com bubble. It also trades at its richest multiple to its inflation-adjusted earnings over the past decade—the valuation method popularized by economist Robert Shiller —in nearly 20 years. The total value of U.S. stocks as a percentage of the U.S. economy, which Warren Buffett once called “the best single measure of where valuations stand at any given moment,” is now higher than at any point during the dot-com years. One argument for stocks may not be as expensive as they seem is that interest rates are extremely low. When the 10-year Treasury note yields just 0.95%, today’s P/E multiple looks less outlandish than it would at a 5% yield. 

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There is a problem with this sort of thinking, however. The 10-year Treasury largely reflects investor expectations of what the overnight rates set by the Fed will average over the next decade. The Fed responds to what is going on with the economy, setting rates higher when it is trying to cool things down, lower when it is trying to heat things up.

But the Fed this year revamped how it sets policy, abandoning its practice of pre-emptively raising rates to head off inflation. In its efforts to help the economy recover, it has committed to hold short-term rates near zero until inflation reaches 2% and “is on track to moderately exceed 2% for some time.” That means that rates over the next several years will be lower than they would have been under the Fed’s previous policy. Perhaps stocks can carry higher multiples and still be reasonably valued. The rules of investing have changed in the past, after all. Investor and financial historian Peter Bernstein noted how veteran Wall Streeters blanched when the dividend yield on stocks fell below the yield on the 10-year—a sure sell signal, they told him. What they missed was the phenomenon of companies reinvesting more of their earnings rather than paying them out. It would be a half-century before dividends surpassed Treasury yields again.

6% profit on Centrica PLC in our upside view

Centrica PLC 20210203 10.41

Citigroup resumes coverage on Britain's largest energy supplier with a "buy" rating and 75p target price.

Centrica EXIT 6

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Why Chinese Startups Still Flock to the U.S. for IPOs

The U.S. remains a magnet for initial public offerings of Chinese technology companies, despite rising political, trade and regulatory tensions between the world’s two largest economies.

More than 20 companies from China have gone public so far this year on the Nasdaq Stock Market or New York Stock Exchange, raising $4 billion in total, according to Dealogic data. Most specialize in high-tech industries such as software or electric vehicles. The sum already exceeds the $3.5 billion in combined IPO proceeds that 25 Chinese companies raised in the U.S. over the course of 2019.

Investment bankers and other advisers say Chinese companies are still lining up to go public in the U.S. and have been largely successful at raising funds from U.S. and other global investors. Listing in the world’s largest, most active and deepest capital market brings companies more international name recognition and a more diverse group of investors, they say. Most stocks of Chinese companies have also chalked up significant gains on their U.S. trading debuts.

The recent accounting scandal at Luckin Coffee Inc., a Chinese coffee chain whose shares collapsed less than a year after its May 2019 IPO, for the large part hasn’t deterred U.S. and other global investors, who remain eager to invest in Chinese companies with strong growth potential, say market participants.

Li Auto Inc., a five-year-old electric-vehicle manufacturer, in late July raised $1.1 billion in a Nasdaq initial public offering that was led by units of Goldman Sachs, Morgan Stanley, UBS and China International Capital Corp.

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Some of the largest share sales by Chinese companies this year have taken place in Hong Kong and Shanghai, however, including secondary listings by JD.com Inc. and NetEase Inc., and that of Semiconductor Manufacturing International Corp. which earlier gave up its NYSE listing.

Chinese fintech and payments giant Ant Group Co. is also preparing for a Hong Kong and Shanghai dual listing that could value the company in excess of $200 billion. Ant didn’t consider a U.S. listing even though its sister company Alibaba Group Holding Ltd. went public there, The Wall Street Journal previously reported.

Chinese companies don’t always thrive in U.S. markets, either. In recent years, numerous U.S.-listed Chinese companies have also been taken private, often by management teams working with outside investors, and sometimes with the aim of securing a higher valuation from a more enthusiastic investor base back in China.

5.2% profit on Alphabet Inc in our upside view

Alphabet Inc EXIT

U.S. Supreme Court hands Google a major victory, ruling that its use of enterprise software provider Oracle Corp's software code to build the Android operating system that runs most of the world's smartphones did not violate federal copyright law ...
The ruling, which comes after the two cos have been at loggerheads since Oracle sued GOOGL for copyright infringement in 2010 in San Francisco federal court, spares Google of a potentially massive damages verdict.

Alphabet Inc A All Sessions 20210303 21.57

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4.7% profit on EasyJet PLC in our downside view

easyJet PLC EXIT

EasyJet's chief executive said that he always expected there to be bumps along the way to a travel recovery and denied that a third wave of COVID-19 infections in Europe put it at risk.

easyJet PLC 20210305 16.33

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New ETFs, Forced to Chase Trends, Shorten Their Own Lives

Last year brought yet more evidence of how hypercompetitive the ETF marketplace has become: Of the 277 exchange-traded products that shut down in 2020, one-quarter of them had been trading for less than three years, according to CFRA Research. One fund was just four months old when it shut in December: North Shore Dual Share Class ETF (DUAL).

The shortening ETF life cycle has implications not only for fund sponsors, according to a new academic study, but also for investors. The researchers found that, because many newly launched ETFs are risky attempts to capitalize on the latest trend, they end up investing in overvalued stocks. One consequence is that such funds on average can be expected to lag behind the broad market’s returns over at least five years after launch—if they even live that long. 

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The study was conducted by Itzhak Ben-David and Byungwook Kim of Ohio State University, Francesco Franzoni of the University of Lugano in Switzerland and Rabih Moussawi of Villanova University. In interviews and emails, these researchers point out that it’s nearly impossible for a newly launched ETF to compete on price against any of the large, well-known ETFs that are benchmarked to one or more broad market indexes. The ETFs from Vanguard Group and Charles Schwab Corp. that are benchmarked to the total U.S. stock market, for example, each sport an expense ratio of just 0.03%, or $3 per $10,000 invested.

So, to attract sufficient assets to give a newly launched ETF any hope of survival, fund sponsors tend to focus on increasingly specialized sectors and investment themes that are currently capturing investors’ attention. While that may help new funds attract an inflow of cash, another likely consequence is that they will own a large number of overvalued stocks.

One theme that is hot now is cybersecurity, for example, and no fewer than five new ETFs that focus on this theme have started trading over the past year. The newest is WisdomTree Cybersecurity Fund (WCBR), launched in late January. According to the fund’s website, its current average forward-looking price/earnings ratio is 77.2, more than three times the S&P 500’s 22.2. This new ETF’s price-to-sales ratio is nearly four times that of the S&P 500.

3.9% profit on Facebook in our upside view

Facebook Inc EXITFacebook Inc All Sessions 20210312 17.49

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Why China’s Growth Sometimes Doesn’t Add Up

Beijing is dealing with a new flavor of China-skepticism in the wake of the pandemic and a more aggressive foreign policy. But certain things aren’t new: Foreigners are skeptical of Chinese economic data. The nation’s strong second-quarter growth, reported at 3.2%, has added further fuel to the debate. 

Two other data points, in particular, have been raising eyebrows. China’s so-called fixed-asset investment, which includes investment in new capital goods and things such as land, fell 3.1% year over year in the first half of 2020, according to official figures, while the investment part of gross domestic product rose 1.5%. One factor behind the big discrepancy might be rapidly rising inventories, which aren’t included in the fixed-asset measure but do contribute to overall investment.

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China’s inventories surged during the first half as production outpaced demand: industrial inventories were 4.3% higher in the first five months of 2020 than a year earlier. Moreover, the unusual combination of rapidly rising inventories and rapidly falling prices suggests that “real” growth in inventories was very high indeed.

That jump—companies were destocking in late 2019—might help explain why overall investment held up relatively well. It doesn’t augur well for the future, though, since prices are still falling and companies can’t build inventory forever. Unless Chinese consumers start spending again and businesses start investing in plant and equipment, rather than hoarding goods, 3.2% growth—or perhaps, somewhat less—might be hard to sustain.

8.5% profit on Intel in our upside view

Intel Corp All SessionsEXITIntel Corp All Sessions 20210121 16.47

Our information/charts are NOT buy/sell recommendations. Are strictly provided for educational purposes only. Trade at your own risk and analysis. Contact our advisors through website chat 24/7.


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