US stock market strategy and scenarios

Matein Khalid

US 2Q earnings were a blowout and will provide additional ballast for the bull market on Wall Street. The scale of the earnings beat relative to expectations has been way above the past quarter or even the past five years at a record 18.6%. While this will keep the ball rolling for El Toro on Wall Street, there are cracks in the macro ice which I am compelled to share with my friends and readers. It is never a good idea to be complacent in global capital markets, especially if we are printing money in the US stock market as if it was Christmas in July.

The Monster Six mega-caps and the overall froth in technology shares has meant that the NASDAQ trades at 28 times forward earnings. This can be justified by the sheer momentum of its growth sectors, asset allocation away from stressed industries like commercial real estate and airlines and the mathematical impact of negative real interest rates on the valuation metrics of high growth equities.

It makes no sense to be a NASDAQ Cassandra as long as the world’s smart money has the feeding frenzy for Big Tech. As the English toff saying goes “the queen is at Ascot, the Tories are in power (just), all’s well with the world”. Yet at the risk of sounding like a party poopah, investors must not forget that the current NASDAQ valuation is a 40% premium to its five year average. What could possibly go wrong and spoil the party just when things are getting red hot?

One, Microsoft’s slowing growth in its Azure cloud platform is an ill omen for one of the consensus darlings in the technology sector.

Two, the Euro surged to my year-end target of 1.18 last week. This is a function of optimism on Europe’s post lockdown economic restart and the prospects for a €750 billion Recovery Fund rather than any intrinsic weakness in the US growth outlook. However, the weaker US dollar does reflect rising angst about a US Presidential election that could well see Joe Biden move into the White House. The Democrats have made no secret about their intentions to put anti-trust and regulatory pressure on Big Tech. This is not what NASDAQ needs, given its nosebleed valuation.

Three, gold’s surge to 1976 suggest that investors are worried about a rise in inflation expectation, a scenario that will only be amplified now that King Dollar has been dethroned by the Euro and, horror of horrors, the British pound (also trading near my year-end target of 1.32 cable).

However, if the world is on the brink of an inflation uptick as gold suggests, this will also mean a sharp rise in real interest rates with the yield on the ten year US Treasury note at 0.55%, a traumatic bloodbath in the bond market seems inevitable at the precise point when sovereign/corporate credit defaults begin to rise. When real rates rise, bad things happen to growth stocks as well as bonds. Valuations compress, things fall apart, the NASDAQ cannot hold, mere anarchy is loosened on the world (sorry for butchering you W.B. Yeats!). Jim Morrison of the Doors said it best – nobody gets out of here alive.

If real rates remotely rise after gold’s $700 an ounce surge, there is absolutely no doubt in my mind a 50% correction in NASDAQ becomes all too possible. When even my insurance salesmen give me stock tips (buy Tesla habibi. Surprise, surprise!). It is time to do some soul searching and portfolio beta introspection. Of course, the bull market in gold could be an inflation false alarm and real US interest rates will stay rock bottom Till the Day of Judgement, as the current NASDAQ valuation implies.

However, as an investor I am neurologically programmed to think hypothetically and conditionally, to trade the markets in the second derivative, to view the world upside down.

I believe investors have still not cottoned on to the fabulous investment opportunities in the rollout of 5G infrastructure, with the penetration rate still only 5%. Yet if South Korea, the world’s most wired society is any proxy, the 2 million 5G subscribers will double to 4 million by the end of 2020. This is why Ericsson shares have become the hottest thing to come out of Sweden for me since Abba, the soundtrack of my boyhood. Ericsson has been a real dancing queen in Stockholm as global sales of 5G software and network equipment surge. Nokia has also risen in Helsinki as it boosts profit guidance and sheds the legacy of its ill-fated Alcatel-Lucent takeover as well as the doomed deals architect Rajeev Suri. Both companies are obvious beneficiaries from the Trump White House crack down on Huawei.

The fall in the dollar and OPEC’s draconian output cut mean that there could be an uptick in Big Oil shares, given the recent news flow from Shell and BP. Even Banks, the ultimate value Cinderella could receive a bid if the yield curve begins to steepen. The only thing certain about this stock market is, in the immortal words of John Pierpont Morgan at a senate hearing is that it will fluctuate.

Matein Khalid is the Chief Investment Officer of Asas Capital Management. He has 25 years of experience in international capital markets as an advisor to family offices and fund managers. He has worked for investment banks/hedge funds in New York, Chicago, London, and Geneva. In addition, he has been the CIO of a technology fund in San Francisco, a royal investment office in Dubai and a public insurance company listed on the DFM.