Liquidity controls the stock market, the recovery takes time

Liquidity controls the stock market, the recovery takes time

21. april 2020Læsetid: 9 minutter

We will see major losses in GDP figures and corporate profits throughout 2020 and perhaps longer. Liquidity is lifting the stock exchanges right now.

We have nevertheless received higher return requirements for some assets as a result of the crisis. One example is commercial Swedish real estate where Atrium Ljungberg wrote down its retail portfolio by about some 10 percent in Q1 2020. This is also due to expected lower rental income going forward.

The stock market trend ended in a positive direction at the end of last week. The US has admittedly received a record of first-time applications, from the unemployed, of which 5.2 million last week. But the New York Stock Exchange looks forward to when the US economy is expected to open again in May. It is unusual in the early days for the United States to arrive late in the Corona epidemic, but it is a balance between the economy and human life regardless. Times of recession and unemployment have also not proved to be good for public health.

The big and decisive issue for the stock market right now is how deep and long-lasting the GDP fall will be. China reported a record fall of minus 6 percent in Q1 2020, which still caused the Asian stock markets to rise on Friday, April 17.

Source: Reuters/Carlsquare

The question that arises after seeing this graph is: Will the recovery be in the form of a V (=back on the old 6 percent line in a year), a U (one and a half to two years to return to previous growth) or at worst an L (even longer recovery time)? The course interpretation according to the strong stock market recycle is that it will be a V. But it will not be. The explanation for the course recoil is instead the stimuli that flow to the stock exchange.

As we wrote in previous weekly letters, electricity consumption is a better quick indicator of the economic slowdown than the purchasing manager´s index. If we look at the outcome for the latter, the trend is falling, but not so strong. Expectations for the March figure in the US, on the other hand, were lower. The April figure should also be reasonably lower than March.

Source: Reuters/Carlsquare

If we study the corresponding figures in Europe, the Reuters forecasts for 2020 are down a Purchasing Manager Index (PMI) of 40, which is a record low. This can be compared to electricity consumption, which fell by 10-15 percent in March in the EU (see last week´s letter).

Source: Reuters/Carlsquare

In Sweden we have seen Volvo and Scania shut down their factories, Assa Abloy flagged for Chinese weakness in its results and a number of other profit warnings in the wake of the Corona crisis, where Essity, which sells hygiene items, was an exception. The Swedish economy is also dependent on the outside world. The shutdown of Scania´s production facilities came after subcontractors in e.g. France could no longer deliver in usual time.

Valuation- Stock market fall in par with falling profits or not?

Below we have produced two graphs that show the relationship between the P/e´s and the price development for the S&P500 and OMX30 indexes. If we start with the S&P500, that index was fundamentally overvalued compared to the historical p/e number multiple in the years 2013-2017.

Today, the S&P500 is trading around 15 percent below its most recent peak of February 19, 2020. Opinion among investors and analysts in the United States is starting to turn more and more towards the price recoil we have seen in recent weeks being exaggerated. This is in view of the economic effects that the Corona crisis has already had and is expected to reap in the future. But so far, we do not see a trend break in the stock market recoil, where the S&P500 index was up 3 percent last Friday. But data trading probably enhances both ups and downs beyond what is fundamentally justified.

Between the OMX30 and the p/e-valuation, there has been good correlation since 2011. The important thing now is that corporate profits do not fall more than the OMX net price decline of about 21 percent since the peak of February 19, 2020.

OMXS30 is dominated by the large Swedish engineering companies with a larger global distribution of sales. It adds an extra sensitivity to the effects of a recession that is relatively larger than the S&P500. This is somewhat offset by the fact that the situation seems to be worse for the American banks compared to the Swedish ones right now.

If we take Volvo as an example, the Group achieved a profit of SEK 12.24 per share in 2018, which increased to SEK 17.64 per share in 2019. The company peaked profit in Q2 2019. Since then, the trend has been falling. According to Reuters, the earnings forecast for Volvo is SEK 8.48 per share in 2020 and SEK 11.00 per share in 2021. Probably, these forecasts are far too optimistic, given that the factories have been closed for a month already. A Volvo share price of SEK 124 gives a p/e number of 14 times for 2020. Should the Volvo share return to the latest peak price of SEK 174.70, the p/e ratio will increase to 20 times. It may well prove to be both 30 times and 40 times on the actual profit when 2020 is completed.

The OMXS30 index managed to close last week up trading above rising EMA9 and MA20. MACD is rising and momentum is thus working in favor of further upwards movement. The next level on the upside is Fib 50:

Note that the bearish rising wedge is still intact which continues to linger as a warning signal from a technical point of view.

On Thursday, Atlas Copco will report its quarterly figures. The share has been doing well in comparison to OMXS30 and has broken up above Fib 50 as well as Fib 61.8. MACD has also generated a buy-signal. On Friday the share was getting closer to MA100 which serves as resistance:

The question is if the report will be strong enough for the share to continue upwards.

SKF is another Swedish company set to report its quarterly figures on Thursday. As shown in the graph below, the share has not developed as strong as Atlas Copco, nor OMXS30. Does this imply that there is bigger room for surprises on the upside?

Swedish retail properties take a hit

The fact that retail is one of the most affected sectors was clear when Atrium Ljungberg wrote down its retail properties by some SEK 1.5 billion or just over 10 percent of its value in the Q1 2020 report. The depreciation of value could be broken down into expected rental income in the future, as well as higher return requirement on this type of property.

This is a trend breach as we have seen uninterrupted value increase on various types of property in recent years, save newly produced tenant-owners after 2017. The big question is whether the trend with higher yield requirements and/or anticipated lower rental income will propagate to the office segment. Crucial will be how unemployment in Sweden develops in the future.

The ranking below of 28 managing real estate companies shows that it is the residential companies that can manage a rent loss worst. But renting losses on housing have so far been marginal. Note at the same time the large interval from 24 percent revenue loss (Amasten) to 74 percent (Sagax) before cash flow becomes zero. The reason for this is that residential property companies have higher operating costs. Furthermore, residential buildings are valued at a lower return requirement than commercial properties. The biggest gap is the return gap between residential and industrial/warehouse space and retail properties in external trade areas.

Source: Carlsquare, Corporate report, Reuters.

As for retail real estate, it should also be pointed out that the sector has been struggling with a declining demand in the physical trading venues for several years already.

According to SEB, credit card purchases in Sweden only decreased by 28 percent during week 15 (April 6-12), compared with 55 percent in Denmark, 60 percent in Norway and 70 percent in Finland. So the negative Corona effect has probably been greater in other Nordic countries and Europe than in Sweden.

The German DAX index is still aiming for Fib 50 under increasing momentum illustrated by a rising EMA9, MA20 and MACD:

But as for OMXS30 index, the bearish rising wedge still linger as a warning flag.

The US company reports

With the major US banks, the Q1 2020 reporting season started in earnest in the United States last week. The proportion of positive earnings results compared to forecasts has decreased from 75 to 68 percent in the past week. The best sectors (apart from Energy, which has only one reporting company so far) are Healthcare and Cyclical Consumer Products with 100 and 86 percent of the results better than forecast. The worst sector on the New York Stock Exchange is financials, with only 47 percent of earnings better than expected.

According to Earnings Insight, a weighted index consisting of a mix of S&P500 companies that have reported their Q1 figures as well as estimates on upcoming reports is that an aggregate profit reduction of just over 14 percent during Q1 2020. This is, by the way, about as much as the S&P500 index has dropped from its peak on February 20.

In terms of revenue estimates, these are the most optimistic for companies in communication (IT) and healthcare. The biggest decline is feared for commodity and energy companies.

If we study individual companies, last week’s trend is clear. There are very sharp downward revisions of profit expectations for the second quarter of 2020, with some very few exceptions. See list of S&P500 companies that have reported below (the column on the far right shows down-revised Q2 2020 forecasts).

Earnings decline for the second quarter of 2020 for the S&P500 companies is expected to be even worse (almost 27 percent lower compared to Q2 2019) according to Earnings Insight. A recovery is started to be included in the Analyst´s forecasts from Q3 2020, but if we compare a quarter to the corresponding year before, we will have to wait until 2021.

As is evident, the Q2 2020 earnings revisions are large and not at least the US banks. The leverage effect of increased credit losses is, as you know, very large in financial operations.

The S&P 500 is still ahead of Europe as the index is trading above Fib 50 and currently wrestling with MA50. MACD has generated a buy-signal. A break above MA50 and the next level can be found around 2 933 where Fib 61.8 meet up. Quarterly reports continue to be in focus along with the Corona-crisis and anticipated reopening of the economy.

The tech sector is leading the race and Nasdaq is pushing to reach the 8 950-level. A break on the upside, and the next level to be reached is 9 160:

On the downside, the first level of support can be found around 8 607.

The USD/SEK is consolidating in a neutral triangle. Note the negative divergence between the development of the pair and MACD. A break to the downside and the formation calls for a move down towards MA100 and MA200 around 9.66. However, on the way down the pair should pass through several support-levels including Fib 50:

In case of an upwards move, the first level of resistance can be found around 10.2.

Gold turned south on Friday as appetite for risk increased. As shown in the graph below, the gold price closed slightly below EMA9. The first support level can be found around 1 672 USD per troy ounce followed by 1646 where MA20 meet up:

Legal notice

This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.

31-10-2020 13:52:53


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