December 7, 2018

What happened this past week? A disconnect emerged this week between the tenor of news, which was on balance favorable for equities (or at least “could have been worse”), and stock price action, which was dreadful – in the U.S., the S&P ended down >4%, the Nasdaq >5%, and the Russell >6%; European bourses dropped >3%; and, the Asian exchanges >1%. On a peak-to-trough basis this week, the S&P swung ~180 points, or >6% (2800 on December 3 and 2621 on December 6), as stocks remain in a period of extreme volatility. The weakest U.S. subgroups included banks, semis, cap goods, transports, and autos. The 2-10 spread briefly broke under 9bp before expanding out a bit towards ~15bp. Brent spiked ~7% thanks to the OPEC action. While a slew of negatives and headwinds are being cited for the sluggish trading action, all the problems can be distilled down to two main issues: 1) slowing growth and 2) trade uncertainty. On the former topic, it isn’t so much that the global economy is sharply inflecting lower right now but instead the growing realization that 2019 could be the peak for the cycle in which case signs would begin flashing “recession” by the end of next year or early 2020. Note that the there isn’t anything appearing in the U.S. data stream to suggest such a dire outlook but investors can’t help but adopt a somber economic disposition given the aggressive Treasury curve flattening. Should this recession fear come to fruition, it would create enormous political headwinds for Trump and the GOP (and should Democrats capture the Senate and/or White House while retaining the House, it would imperil the tax bill). Keep in mind deficits are already a growing political problem but they are set to explode as growth decelerates and entitlement spending stays unreformed. The S&P $178 EPS number for 2019 should hold and that provides strong valuation support at ~2650 (for at least the first and second quarters of ’19) but to the extent ’19 is seen as a peak, the PE won’t have much expansion potential. On trade, the last week could have gone worse (Trump and Xi achieved a fragile détente that will forestall incremental tariffs on December 1) but there is still a ton of uncertainty on this topic (especially after the arrest of a prominent Chinese telecom executive). Bottom Line: in times like we are experiencing now, the strong fundamentals (currently above average economic growth and appealing single stock valuations) take a back seat to technical indicators. The October stock index lows are so close that they become magnets, and will probably result in an overshoot in the near term, but subsequently we expect a strong rebound which can be used to transition from a long-biased to a short-biased stock portfolio going in Q1-Q2 2019.

The focus in the coming week will on economic data, specifically China’s November numbers (imports/exports December 8 and retail sales, FAI, and IP out December 14), German October trade (December 10), the U.S. CPI for November (Wednesday, December 12), and the flash PMIs for December (out Friday, December 14). In addition, the final ECB meeting of the year takes place Thursday , Italy is expected to submit fresh budget figures to Brussels on Wednesday, December 12, and the May Brexit blueprint is likely to fail when it comes up for a parliamentary vote on Tuesday, December 11. Couple these expected headlines with the never-ending unscripted trade headlines, global stock markets are set up for another volatile week ahead.

Your BSD Global Tech investment mandate is 94% fully invested across 10 tech vendor sectors and a number of legitimate technology end-users, while carrying a 32% short equity indice derivatives position (on the notional value of the stock portfolio) to protect us from those inevitable market drawdowns. If the market’s fundamental / technical / capital flow foundations suffer a material change, We will adjust our long biased stock portfolio and our short derivatives hedge.