|By Matein Khalid| US and global equities surged on news of the US House of Representatives pass the tax reform bill, Cisco and Walmart posted blowout earnings and a potential bidding war emerged for Fox’s media assets. The rally on Thursday followed a week of carnage in the US high yield debt markets, flattening of the US Treasury yield curve and losses in the major stock market indices worldwide.
The 227 – 205 vote in Congress on tax reform illustrates the political polarization in Washington. This means there will be a tough political battle for tax bill in the Senate, even among Trump foes in the Republican Party. The GOP controls just 52 Senate seats, the Democrats will oppose the rich dude/corporate tax cuts with their usual loony left passion and Wisconsin Senate Ron Johnson has announced he will vote against the bill. If Theresa May faces a revolt in Westminster, Trump could well face a Republican revolt in the US Senate. This will be a Lehman scale shock for global financial markets if it happens, as I expect it will.
The military coup against Robert Mugabe in Zimbabwe means the South African rand is an obvious short. After all, Jacob Zuma’s ANC is very close to Mugabe’s ZANU – Patriotic Front. Mugabe turned Zimbabwe into a personal fiefdom and an African financial basket case. The former Rhodesia has huge economic potential if the military establishes a credible technocratic government. Mugabe leaves office with a 200% inflation, a 90% unemployment rate and capital controls. The economy is hostage to Chinese State owned companies beholding to Beijing and tribal tensions between the Matabele and Shona people that predate even the arrival of Cecil Rhodes, let alone Ian Smith. Could Harare be the next frontier fairy tale? Stay tuned.
In Europe, I expect profit taking in the Euro Stoxx 600 index to test 384. The earnings and economic growth momentum that made European equities a must own has now abated. The upward revision ratio in European earnings has fallen to 51, the lowest since late 2015. The 40% rise in oil prices since June will hit margins, as will the rise in the Euro once corporate FX hedges roll out. The real problem in Europe is the mediocre profit results at major banks like Credit Agricole, UniCredito, ABN Amro, BNP Paribas, Société Générale and Deutsche Bank. Awful trading results and a flattening Euro yield curve do not help nor does the prospect of the Italian election.
I was stunned to see Walt Disney trade higher to 104 even though it missed on both revenues and profits. Obviously, investors are electrified by the new Star Wars trilogy, a new streaming service to compete with Netflix and new TV series based on priceless content at franchises like Marvel, Pixar and Lucasfilms. Sports content ratings are a blowout. My trading range on the Magic Kingdom, executable via Chicago options, is 96 – 110.
I see significant money making opportunities in Singapore, US and British real estate investment trusts. Amazon’s (and E-commerce’s) insatiable appetite for warehouses and distribution centres make industrial REIT’s the segment darlings de jour. Shopping mall shares are a disaster, down 18 – 20% even while industrials like Prologis are up 25% and scale new highs. US industrial real estate has pricing power I cannot ignore.
I believe Hong Kong property developers are now a screaming short. Li Ka-shing, Asia’s wealthiest billionaire, sold his Central flagship skyscraper to a Chinese state firm for $5.2 billion, a world record for a single building, or HK$ 33,000 a square foot. Brokers are scrambling to resell entire floors at up to 50,000 Hong Kong dollars as the Chinese buyer seeks to finance the trophy asset. This is insane. This is Tokyo, 1989. The Hong Kong interbank offered rates has surged. Banks will raise the prime rate for the first time since 2006. Hong Kong’s stratospheric home price index has begun to sag and number of transactions have plunged, invariably an ominous sign. The Fed rate hikes will be a kiss of death. Yes, this time the wolf is here in Central!
Russia is an emerging markets Cinderella at 6.8 times forward earnings, 14% earnings growth and a 5% dividend yield. Yes, Putin is still in Crimea, the cyber-espionage hacking scandal will not go away. Yet the Russian economy has emerged from recession. Lukoil and Rosneft will raise their dividends. Sberbank has been a fabulous winner. A hundred years ago, Lenin and Trotsky overthrew the last Romanov Tsar and Alexander Kerensky’s provisional government. The USSR was a seventy four year nightmare for Russia and the world. Yet there is profit potential in Russia’s equity index fund.
Currencies – Sterling’s trading range amid political & interest rate risk
Sterling was on the ropes last week on political risk as Prime Minister Theresa May faced a no-confidence vote from the ranks of her own Tories. No less than 40 MP’s in the House of Commons would sign a letter of no confidence against Mrs. May, just short of the 48 needed to trigger a leadership challenge. Mrs. May’s botched general election campaign and now this Tory revolt in Westminster weakens her hand in the Brexit negotiations with the EU. This means lower “soft Brexit” risk and so a lower sterling. The news that Boris Johnson and Michael Gove, the two most visceral Brexit fanatics in the Tory political constellation, wrote a “secret letter” to the Prime Minister outing their plans for Brexit without a trade deal with the EU is also sterling bearish. The leaks also demonstrate the bitter political divisions in the Tory Cabinet and among backbenchers MP’s.
As if all this was not bad enough for Downing Street, the EU has turned nasty in demanding a financial divorce settlement from Britain. Northern Ireland’s post Brexit border with the Irish Republic is another brewing political time bomb and the Prime Minister is compromised with her reliance on the Democratic Unionists to maintain her parliamentary majority. I now fear Planet Forex will test sterling lows below 1.30, possibly down to June and August trendline support in the charts.
Anti-corruption crackdowns in China and Saudi Arabia mean a sharp fall in offshore flows into British property at a time when Brexit has gutted investor sentiment, rents and transaction volumes for the City of London commercial property. The fall in financial flows into UK gilts, shares and London property is unquestionably sterling negative.
Positioning data from the Chicago futures market suggests speculators have shifted from net buyers to net sellers on sterling. At the same time, one-month implied volatility on cable has risen 13 per cent while risk reversals have swung 20 basis points. True, sterling has priced the bad politics and EU news though not Mrs. May’s resignation or a collapse in Brexit trade talks mean cable plunges to June lows at 1.28. The US dollar’s outlook, UK economic data and the prospect for a second Bank of England rate hike are. Mark Carney’s “dovish rate hike” was unquestionably the reason sterling failed at 1.36 and I immediately scaled back the odds of a 1.40 post referendum retest. Net net, cable trades in a 1.28 – 1.34 range next month. I am a seller on strength. In the Age of Brexit, Boris and the Bank, sterling volatility is king.
The slide in the US/global stock markets in the five trading sessions has seen the Euro spike to October highs at 1.860 as I write. The Japanese yen has also surged to 112.60 on clear evidence of safe haven buying as the Nikkei Dow loses a 1000 points and Asian equities succumb to the spasms of risk aversion.
I was stunned to see iron ore plunge 5% in a single session and take the Aussie dollar down with it and there are now rumors in Canberra that Prime Minister Malcolm Turnbull, despite his Goldman pedigree, is on his political death rattle while the RBA is on hold. With three Fed rate hikes in 2018, I can see the Aussie dollar plunge to 68 cents if the global economy slumps next year. The fall in Brent crude after the US inventory data has taken a predictable toll on emerging petrocurrencies. The Russian rouble has now fallen to 60. The Mexican peso, which faces NAFTA/Trump risk, is at 19.20 despite the central bank’s foreign exchange hedge auctions. The US dollar’s woes and UK wage data alone presented sterling from falling below 1.30 on Westminster and Brussels risk.
Fed Funds futures contracts in Chicago imply that the capital markets now price in one rate hike in 2017 after the carnage on Wall Street last week, not the three rate hikes implicit in the FOMC dotplot. This is insane, especially if the US Congress enacts tax reform. Though I await the Senate version, there is no doubt that the illusion of revenue neutrality has been jettisoned by America’s legislators. Trumpian “trickle down” economics means a trillion-dollar Uncle Sam deficit, a surge in wage pressures and inflation risk, a bloodbath in the bond market as interest rates spike next year. The Yellen (or Powell) Fed are behind the curve. The US Treasury yield curve continues to flatten, a sign of sure future central bank hastiness (monetary tightening).
Stock Pick – Fox surges 30% on news of Wall Street bidding war!
The biggest bombshell is global media last week was the revelation that Disney, Comcast and Verizon were in talks to buy some of 21st Century Fox’s strategic brands, such as Sky (the UK/Europe’s preeminent pay TV platform with 22.5 million subscribers), Fox’s cable networks (FX, National Geographic), Hollywood movie studio (X-men, Avatar) and international assets (Star TV). This led to an immediate 30% surge in Fox shares, which I had profiled in this column on June 19, 2017 as an undervalued global media conglomerate. Something big is obviously happening in the House of Murdoch.
Citizens Rupert’s son James is the CEO of Fox in New York and the potential sale of Fox’s television, film and cable assets could well ignite a bidding war that could well involve Comcast, Charter communications, Verizon, Amazon in addition to the House of Mouse in Burbank. The Disney talks confirm one basic fact. Fox is in play on Wall Street and the world’s most powerful content generators and cable networks cannot ignore its media assets, technologies, brands and distribution platforms. So my recommendation to own Fox was a license for UAE investors to make money in this bidding war.
The dismemberment of Fox’s media empire is a response both to the failure to gain control of Sky with a $15.4 billion bid opposed by the UK regulators and powerful politicians in Westminster as well as the sheer scale of the AT&T-Time Warner merger. Given that Rupert Murdoch is 86, the world’s richest media clan could well have decided that the timing was right to solicit and receive top dollar bids for some of the world’s most coveted media brands and distribution platforms. After all, the Fox movie studio is only fourth in box office receipts in Hollywood and a merger with a larger studio might be the only solution to flat audience growth in the age of Netflix and YouTube. Cord cutting is a fact of life for every major cable network, including Disney’s ESPN and CBS’s Nickelodeon. Streaming video has devalued the growth potential of both global film and television assets. Disney is also desperate for direct engagement with media consumers, the reason why Bob Iger so covets, say, Sky or the Star TV brand in India.
The grapevine in New York is that Fox wishes to retain its sports and news core, which could be worth at least $27 billion and sell the 39 per cent stake in Sky, the digital streaming Hulu television, cable networks, and, above all, the underperforming $14 billion Hollywood movie studio. In essence, the Murdochs have decided to exit the film/cable business and decided that the British politicians/regulators will not approve their takeover bid for the whole of Sky. The legacy of the 2011 phone hacking scandal in Murdoch clan’s London tabloids makes them politically toxic to Prime Minister Theresa May’s Conservative Party.
One potential scenario is that the Justice Department blocks AT&T’s bid for Time Warner. Donald Trump detests CNN as the embodiment of “fake news”, after all. If this happens, the Murdoch sons James and Lachlan may covet Time Warner, for whom Rupert Murdoch made an abortive bid three years ago. This is a real life media game of thrones in Tinseltown and Manhattan. What does all this mean for investors?
The Big money in Fox shares was made last week. I doubt if Fox shares can rise much above 32. Disney is the world’s preeminent content generator and I seriously doubt if Fox’s television production or cable network assets (other than Sky and Star) are a value enhancing strategic fit. Television advertising has been gutted by the rise of Google and Facebook. Yet for now, Wall Street will rerate Fox, which can well generate $5 billion in earnings next year.
Rupert Murdoch’s control of Fox has been compromised by the arrest of his ally on the board Prince Waleed bin Talal. The Saudi prince’s 5% voting stake helped Murdoch control the Fox board. The Murdoch clan own 14% Fox but control 38% of voting shares. So the news from Saudi Arabia reinforces the odds of a strategic sale of Fox’s non-news and sports media brands. Technological revolutions like the Internet and social media have upended the business models of film/television companies and able operators. The sheer scale and power of Netflix, Google, Facebook and Apple means a new wave of mergers and assets sales is inevitable, as the AT&T bid for Time Warner and the Disney-Fox talk attests. Whatever happens, Fox’s $28 billion revenue media empire faces potential dismemberment.
Also published on Medium.