For European Markets, 2019 Was the Year of the Deal
It has been a mixed year for Europe, which saw Germany’s powerhouse economy flirt with recession and the United Kingdom divided by uncertainty over Brexit.
On the upside, fiscal discipline should improve in Italy, and growth is rebounding in Spain. The iShares Core MSCI Europe exchange-traded fund (ticker: IEUR), composed of large-, mid- and small-cap European equities, is up 23.6% this year, compared with a 27% gain for the S&P 500 index—a strong performance despite investors withdrawing more than $100 billion from European equities.
Giles Rothbarth, co-manager of the BlackRock European Dynamic fund, says the market has been driven by ample mergers-and-acquisitions activity and share buybacks. LVMH Moët Hennessy Louis Vuitton (MC.France) is paying $16.2 billion for Tiffany (TIF). A bid of five billion pounds sterling ($6.6 billion) for U.K. food-delivery firm Just Eat is heating up, and Fiat Chrysler Automobiles (FCA) and Peugeot owner PSA Group (UG.France) confirmed a $50 billion merger deal.
In September, a package of easing measures from the European Central Bank saw flows gradually return to European stocks because investors took it as a sign that the central bank would not let the economy worsen.
Rothbarth said that sectors such as energy and banks lagged behind due to a highly competitive backdrop and little to differentiate various product offerings. Information technology led the European market, with the semiconductor industry driving strong returns “as the inventory destocking cycle nears an end and investors once again became excited by the secular growth story,” he says.
European earnings overall have been downgraded over the year, he says, but the market has had pockets of strength. One such area in which he has significant exposure is luxury goods, where “heritage brands with strong management teams executing successfully on growth have seen ongoing earnings upgrades,” he says.
Two stocks mentioned in this column have outperformed. Ocado Group (OCDO.UK), billed as the Amazon.com (AMZN) of the grocery market, licenses artificial intelligence and robotic systems to help supermarkets deliver food ordered online. It signed licensing deals with grocery giants including Kroger (KR) in the U.S., Sobey in Canada, and Coles Group (COL.AU) in Australia. In November, Ocado struck a deal with Aeon (8267.Japan), Japan’s biggest supermarket chain. Ocado’s shares have soared about 55% so far this year.
Theme-park operator Merlin Entertainments, the world’s second-largest visitor attraction operator behind Walt Disney (DIS), was recommended in this column at 389.30 pence. An activist investor suggested that the operator of the London Eye and Madame Tussauds should go private, and the “share price does not reflect the underlying value of the company and may not in the foreseeable future.”
Just weeks later, Merlin agreed to a £5.9 billion takeover bid from the owners of Lego and a consortium of investors. Merlin’s shares jumped, and its last traded price was 454.60 pence.
Not all of the recommendations were on target. In May, Renault (RNO.France) looked ripe to benefit from consolidation in the auto sector, and the stock was recommended here at 49.97 euros ($55.55). A week later, Renault announced a proposed merger with Fiat Chrysler, and Renault’s shares jumped 14%. But the deal was not to be. Fiat Chrysler this week signed an agreement to merge with PSA to create the world’s fourth-largest car maker. Renault’s shares have been left in the parking lot at €43.52.
Barron’s Weekend Summary: Cover feature profiles legendary investor Peter Lynch; stories look back on 2019 and ahead to 2020
* Cover story: Profile of legendary investor Peter Lynch, who at age 75 has spent 50 years at Fidelity, where he holds one of the greatest track records—an astonishing 29% annualized return from 1977 until 1990—nearly double what the S&P 500 index produced in the same period; He says investors should buy stocks regardless of whether the market is rosy or bleak, and that “The thesis underlying everything, whether you’re an actively managed fund or a passive fund, is that the US will be OK. If you don’t believe that, you shouldn’t be in the stock market.”
* Tech Trader: The column looks back at the calls it made in 2019—some good, some bad—and says the major story of the year was Big Tech coming under antitrust scrutiny, with the competitive practices of AAPL, AMZN, FB, and GOOGL facing regulatory investigations.
* Trader: There are just six trading days left in 2019, and the market doesn’t seem to be able to stop going higher—but the year’s gains were possible only because the market entered 2019 positioned for a recession and instead got a “muddle-through”; Cautious on BBBY: Columnist Ben Levisohn says he regrets a call to short the stock after the company named Mark Tritton chief executive—it still has a lot of work to do, and while he doesn’t recommend buying, nor does he suggest shorting it; Many companies are using “reverse factoring”—the market for supply chain financing has been growing quickly, and the debt is making its way into funds offering yield, though accounting rules don’t say much about how it should be reported.
* Profile: Sam Hutchings and Mark DeVaul, portfolio managers at American Beacon The London Company Income Equity fund, seek outperformance by targeting market inefficiencies around risk, rather than reward, and select companies based on estimated worth in a weak economic environment (top 10 holdings: AAPL, CINF, Berkshire Hathaway, MRK, WFC, TXN, CSCO, D, NSC, DEO).
* Features: 1) In an interview, Peter Lynch says that “Growth stocks are better than non-growth stocks. Growth stocks, by definition, are where sales have really grown. People confuse it with earnings going up, but if you just look at earnings growth you mix in turnarounds and cyclicals”; 2) Cautious on CHL: The leader in the Chinese wireless market has 946M mobile customers, 10 times those of VZ and T and almost three times the US population, with more than $100B in annual sales—but that size hasn’t translated into stock performance; 3) “The most sweeping changes to the US retirement system in more than a decade have passed Congress and are widely expected to be signed into law before year’s end, leaving little time for pre-retirees and current retirees to digest a spate of new rules that are aimed at increasing Americans’ access to work-based retirement plans and helping their savings last longer”; 4) Positive on BDX: A strong US dollar has pressured the company’s earnings, and there is regulatory concern about its drug-coated Lutonix balloon for treating patients with peripheral arterial disease, but these hurdles may be causing investors to overlook a solid company with a healthy business that generates robust cash flow.
* European Trader: An overview of Europe in 2019 says it’s been a mixed year for the Continent, “which saw Germany’s powerhouse economy flirt with recession and the United Kingdom divided by uncertainty over Brexit”—and while European earnings overall have been downgraded over the year, the market has had pockets of strength.
* Emerging Markets: Most of the events that dominated emerging markets in 2019 were made in the US, including the Federal Reserve’s shifting mood on interest rates and Donald Trump’s unpredictable turns on trade with China.
* Commodities: “This year has been good for commodities, with palladium leading the way with a gain of nearly 60%—the precious metal has continued to notch new highs, stealing the spotlight from cheese and milk prices.”
* Streetwise: Columnist Jack Hough looks at the decade’s 10 highest-returning S&P 500 stocks: NFLX, MKTX, TDG, AVGO, ABMD, URI, REGN, ULTA, ALGN, and ODFL.
The economy is king in Donald Trump’s re-election bid
The consensus is 2020 will see another year of this happy miracle of growth and low unemployment
Early in 2018, Republicans in Washington ran an experiment: after passing a tax cut, they poured additional government spending into an economy that didn’t seem to need it. Democrats gave them the votes to do it. Most macroeconomists expected new jobs but also higher inflation.
The jobs came. The inflation did not. The experiment worked. In 2020, Republicans plan to repeat it, this time without the tax cut. They will shower money on to a hot economy. Democrats, again, have already helped them. US president Donald Trump will face many obstacles to his re-election next year. The economy will not be one of them.
The 2019 data has been hard to explain. Corporate investment collapsed. Confidence among chief executives dropped to a 10-year low. But unemployment has remained at or below 4 per cent for more than a year and a half. Working-age adults continue to rejoin the labour force. Hourly wage growth for workers not in management is at 3.7 per cent. Inflation remains stable and feeble.
The consensus among Wall Street and US Federal Reserve economists is that 2020 will see another year of this happy miracle: low business investment, decent economic growth, continued historically low unemployment and reasonable pay rises. “It’s difficult to see an economy that’s not OK,” said Ellen Zentner of Morgan Stanley. Her forecast is only slightly more optimistic than most: 1.8 per cent gross domestic product growth, 3.2 per cent unemployment, and a modest uptick in business investment. If 2020 proves to be a pocketbook election, this is all good news for an incumbent.
To explain this success, Republicans look back at the past two years and see a faithful application of conservative principles. They lowered business taxes. They cut regulations. But it is hard to find evidence that either of these things worked at the scale the GOP had hoped.
Corporate tax cuts are supposed to create long-term growth through investments in new plants and gear. That makes labour — and the economy — more productive. But business investment has been unimpressive for the past two years, and has actually declined since the summer. Measures of worker productivity have declined, too.
The costs and benefits of regulations are notoriously difficult to quantify, but even if we take the White House’s estimates of what businesses saved at face value, we end up with a total of $13bn in 2019. Over about the same period, the US economy grew by $530bn. Deregulation explains just 2 per cent of that growth; the scale is similar all the way back to 2017. You could argue that deregulation encourages businesses to invest, but again: we haven’t seen a lot of investment.
Maya MacGuineas, head of the Committee for a Responsible Federal Budget, has an alternative explanation: “The talking points are that it comes from tax cuts and regulation. The reality is that it comes from a massive run-up in government spending.”
To understand what she means, take a look at the peculiar way in which the US creates its federal budget. Since 2013, Congress has appropriated money under “sequestration” — arbitrary spending caps that were designed intentionally to be so destructive that Congress would have to agree on something better. But it never has.
For the past six years, fiscal policy in Washington hasn’t been about passing a budget. It has been about minimising the damage from sequestration. Former president Barack Obama was able to negotiate a bit with Congress, lifting the sequestration caps by between $20bn and $50bn per year.
Then, under Mr Trump, everything became more generous. In February of 2018, a bill — passed with support from Democrats in the House and the Senate — lifted the sequestration caps to add $143bn in spending in 2018, and $153bn in 2019. At the time, the non-partisan Congressional Budget Office was forecasting that the US economy was already at capacity and could not speed up without causing inflation.
This prediction proved so untrue that in August of this year, Republicans and Democrats got together and again agreed to raise the sequestration caps, this time by $168bn in 2020, and $153bn in 2021.
This spending shows up clearly in America’s quarterly GDP numbers. Between 2013 and 2018, federal spending was a drag on GDP. Since 2018, Washington has written enough cheques to add on average a quarter of a percentage point to economic growth.
For the past two fiscal years, and the next two, Congress has agreed to a spending stimulus for Mr Trump’s economy that is three to five times greater than that given to Mr Obama. Republicans may not describe events that way. But that doesn’t stop them from enjoying it.
Ms Zentner points out that another stimulus is coming in 2020. The federal government is expected to hire 400,000 temporary workers by May to carry out a constitutionally mandated decennial census. Job growth in census years “looks like a patient that’s plugged in to the heart machine at the hospital,” she said, “you get a massive wave of hiring around mid-year.”
Japan to raise military spending to new record
Investment in air defence to counter perceived threat from China and North Korea
Japan will increase its military spending for an eighth consecutive year to a record high as it invests in ballistic missile and air defence to counter a perceived threat from China and North Korea.
The national budget for the year to March 2021, unveiled on Friday, included a 1.2 per cent increase in defence to ¥5.31tn ($48.6bn) alongside a jump in social security spending to provide support for the ageing population and free childcare.
The administration has increased defence spending steadily since Shinzo Abe came to power, boosting it by a total of 13 per cent from the trough in 2012, although that is dwarfed by the military build-up in China. Japan’s defence spending remains around 1 per cent of gross domestic product, which is low by global standards.
In a recent interview with the Financial Times, Taro Kono, the Japanese defence minister, said that a lack of transparency in China’s military spending added to “global anxiety” over its intentions.
The defence budget marked a further shift in spending towards advanced air defence capabilities and the acquisition of US military equipment, rather than shipbuilding or investment in ground forces.
“We’re putting in place a highly effective defence capability, both in terms of strengthening our capacity to deal with the national security environment and efficient management of defence spending,” said Yoshihide Suga, chief cabinet secretary.
Japan will buy nine F-35 fighters from the US in the budgetary year at a cost of ¥107.4bn, including its first six of the short take-off F-35B version, which can operate from small aircraft carriers and island airstrips.
It will invest in maritime patrol aircraft and air-to-air refuelling capacity: both useful in projecting power around the disputed Senkaku Islands, known to China as the Diaoyu.
Japan is weighing how to replace its F-2 aircraft once they start leaving service in 2035 and the budget allocates ¥28bn to start work on a new domestic fighter programme. The programme will be split between initial work on aircraft design and research on the systems integration capability Japan would need to build a fighter by itself.
The Trump administration is pushing Japan to choose a US company as its partner for the future fighter rather than working with BAE Systems of the UK. Japanese defence officials said a new fighter should be developed “under our leadership” and that their options remained open.
The budget reveals how Mr Abe’s conservative government is increasing both taxes and spending as it tries to sustain economic growth and deal with pressing problems in both national and social security.
Japan’s regular budget for the 2020 fiscal year is separate from the $121bn stimulus package announced this month, although much of the spending will occur in the same period.
“Following the basic principle of the Abe administration that there can be no fiscal stability without economic growth, we continue to reform spending in pursuit of both,” said Mr Suga at a press conference after the cabinet agreed the budget.
Mr Suga said that interest costs, exceptional spending and transfers to Japan’s regions had declined, but the use of revenues from a recent increase in consumption tax to provide free education for children and support for the elderly would mean a total spending increase of ¥1.7tn to a record high.