If we told you that equities would be flat yesterday in US session on the backdrop of weaker than expected Chinese macro, the biggest oil shock since the early 1990s and a galloping USD funding crisis, you have rolled your eyes. But that’s the market as of yesterday. Equities are a bit risk-off this morning, but all equity markets look like they are rolling over, so unless FOMC tomorrow delivers some magic on the guidance then traders should shift into short positions on equities.
USD funding crisis is serious
The talk of town yesterday was the apparent spike in the FRA-OIS spread which is essentially the spread on LIBOR-Fed Effective Rate swap. If this spread rises the is a USD funding issue and creditworthiness among banks is deteriorating. In addition to the blowout in the FRA-OIS spread the general collateral repo rate in the US funding market also spiked yesterday sending worrying signals to the market that the Fed might be losing control over policy rates. If the FOMC is not openly talking about these events and downplaying the current situation then it’s risk-off tomorrow across the board as it will be a policy mistake on par with the December 2018 decision to hike.
Emerging
market equities are obviously feeling the heat the most from stronger USD and
higher oil price which are squeezing emerging market consumers and government
finances in local currency. The weaker than expected Chinese macro data yesterday
also support downward trajectory in emerging market equities.
Why did the oil shock not move equities more?
We are
getting a lot of questions why the oil shock has not moved the overall equity
market more. While the energy market is important for the world it’s no longer
that important for market value as the energy sector is only 5% of the global
equity market. Global equity markets are driven by financials and technology companies
which profits are quite insensitive to energy prices, at least at current
levels. In addition, the capital expenditures among energy companies are still
down 50% from the peak in 2014 so the jump in oil price will not feed through to
real investments anytime soon.
However, the
latest news from Aramco is that it could take weeks and months to restore oil
production back to where it was before the attack. We see the pain point for
Brent Crude into the equity market at around the $80/brl level so there is
still some margin of safety. The real threat to global equities comes from
geopolitical risks on the rise with both Saudi Arabia and the US pointing at
Iran as the culprit of the weekend’s oil attack.
Stocks to watch
Sentiment
on Apple shares is in short-term a struggle between better than expected demand
for the new iPhone 11, especially in the Chinese market where Apple has
struggled, and a potential $14.4bn tax bill issued by the European Union. On the margin Apple’s news flow is positive
and the uptake in iPhone 11 demand is more important than a potential tax bill
in the EU only 25% of the last 12-month free cash flow. Investors are
agreeing to this view with the share price up 57% since early January when
Apple cut its guidance on a weak Chinese market. However, Apple is not paying
the $14.4bn tax bill levied on the company in 2016 by the EU Competition Commissioner
Margrethe Vestager without an EU court fight which takes place this week. If
the EU court decides that Apple’s tax deal with Ireland was illegal it could
permanently squeeze Apple’s profit margin as profits in the EU would be taxes
at a higher tax rate going forward.
We Company, the former WeWork, is said to have
postponed its IPO following significant negative news flow around its CEO and
founder, and its lack of good corporate governance. Not even lowering the valuation to around $10,
which is far less than the previous private round valuing the company at $47bn,
was enough to spur interest from investors. We do not think We Company will
come back successfully to public markets as the public relations damage has already
happened and will most likely haunt the company for years. We Company is just
one more recent Silicon Valley IPO which is valued at too high valuation levels
and come with usual Silicon Valley dual share class system. We sense that the
Silicon Valley reputation has taken a massive hit over the past two years and
the perception is changing around technology companies.
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