TheChek News Flow

Rotations are a constant feature beneath the surface of markets and nothing quite animates conversation at the moment than the prospects of a bigger shift into “value” or cheap areas of equities. This is a global equity story that also meshes with a theme that will define the coming decade: the next industrial revolution.

The latest equity rotation towards value dates from mid-August when long-dated sovereign bond yields set their lows for the year.

Over at JPMorgan, its global quantitative and derivatives strategy research says the shift towards value is only phase one, and one largely driven by a bounce in shares from very cheap levels. In terms of the S&P 500 index, JPMorgan thinks “only ~20% of the momentum/value rotation is complete” as charted below. The bank also estimates: “Europe follows with ~15% of the rotation complete, while in Asia and Japan the rotation has barely started.”

In recent conversations with a number of investors, the general view is that the attraction of value can hold for three to six months, and then lapses, repeating a pattern of brief rallies over the past decade. In turn, owning growth companies is still viewed as an appealing strategy against the backdrop of a slowing global economy. Sticking with high-quality and defensive companies also has its allure, given that trade and political risks remain high. 

Ultimately, the question of a sustained tilt towards value (where financials have an outsized presence) boils down to whether the global economy finds a firmer footing that extends the current business cycle. That, in turn, entails long-dated bond yields climbing higher and yield curves steepening.

Such a scenario does not just bolster value and cyclicals, it tends to pressure growth stocks, as the attraction of companies in expansion mode and with pricing power is desirable against the backdrop of sluggish economic growth and disinflationary winds. Momentum stocks, or those with low volatility versus the broader market, also suffer when yields start rising as they no longer look so appealing. 

JPMorgan makes the case that “the second phase should be propelled by better macro-fundamental data and cycle recovery”. The banks adds:

“Recovery of the global business cycle (and by extension global bond yields) is essential for the rotation to continue. For the first time in 6 months, our three regional business cycle indicators (QMIs [Quantitative Macro Indices] for US, Europe, and Asia) are in recovery/expansion.”

Now there are plenty of doubters about the merits of a sustained global upswing in 2020. That said, it won’t take much to lift companies that are barometers of economic activity next year. 

In terms of cyclical industries’ profits, Steven Wieting, global chief investment strategist at Citi Private Bank, says they have raised “US and global 2020 [earnings per share] expectations from 4% growth to 7%”. He adds:

“Of course, this could be exceeded, as the experience of 2017 showed. However, our forecast is consistent with at least a narrow agreement being struck to avoid tariff escalations between the US and China and the US and EU in the coming year.”

But there’s another important angle for investors: the coming era of industrialisation; one transformed via advances in artificial intelligence, big data, automation and 3D printing, and what this ultimately entails for “old economy” companies based in that sector.

A few months ago Steve Blitz at TS Lombard certainly made me think when he outlined at a London seminar how the average age of US fixed assets was the oldest since the 1960s. That, according to Steve, reflected a manufacturing sector waiting for the new wave of robots and automation, and all seamlessly connected via a 5G network. That is not good news for human jobs, but likely means more goods eventually being produced in the US, given the big cost savings. 

This coming transformation and boost in capital expenditures in the next decade was very much a part of a recent conversation I had with Frédérique Carrier at RBC Wealth Management. This week RBC published its 2020 outlook, which includes a section looking at the new industrial revolution and how it stands to transform “the investment outlook for the Industrials sector”.

“Advances in factory automation could be reaching the point where ‘lights-out’ manufacturing plants become widely feasible” and “today we are seeing a deluge of new applications for robotics and automation”.

Other game-changers are smart systems that stem “rampant water leakage” for utilities, while advances in 3D printing are another important driver of efficiency gains.

Such promises come while investors show little love for the sector. As shown below via RBC, the S&P Industrials sector is certainly cheaply valued relative to the broad market, languishing near its lows plumbed during the global financial crisis.

This raises the prospect of both short- and longer-term opportunities for investors willing to do their homework on the sector. 

Frédérique makes a couple of contrarian points for the coming year:

“The industrial sector tends to outperform when value beats growth. It is less vulnerable to fears of a potential Democrat sweep in 2020 than other cyclical sectors. Industrial companies are also actively buying back stocks and could benefit should the trade war enter a détente phase in 2020, ahead of the presidential elections.”

And taking a longer-term view, Frédérique adds:

“Today’s heavily discounted valuations within the Industrials sector make this an especially opportune time to seek out the groups and companies that are likely to establish competitive advantages in this transforming industrial world.”

The recent weakness in new listings has injected a dose of reality

After the dotcom bust, Dan Chung, chief investment officer for Alger, a tech-focused fund manager based in New York, was desperate for hot stocks to fire up his portfolios.

In 2003, he spotted a small-cap stock that had dropped 65 per cent in the five months after going public. The company — a specialist in mail-order DVD rentals — was increasing its revenues, but investors had soured on it, worrying that it was precisely the type of risky business that had contributed to the big crash.

Mr Chung snapped up stock in the company, Netflix, for $1.20 and within a year the price had climbed fivefold.

The gain was a lifeline for Alger, which had suffered outflows after being hit hard by the 9/11 attacks. The holding boosted the asset manager’s small and mid-cap funds, helping stem a wave of withdrawals. Netflix stock would climb further, breaching $200 in 2017, the year Alger sold its stake, to more than $300 today.

“After 2001 we lost a lot of clients,” Mr Chung said. “We were trying to prove we could stay in business.”

Mr Chung’s big bet on a beaten-up newcomer is worth considering, as a chill descends on some of this year’s newly-listed companies.

The five largest US deals of the year, which all fall into the “unicorn” category of private companies worth more than $1bn, have lost an average of 24 per cent of their value since going public. Three of the five remain lower than their IPO price, including Uber, the year’s biggest newcomer, which has lost 37 per cent since its debut in May.

SmileDirectClub, the teeth straightening start-up, is down 60 per cent since listing in September, wiping out about $5bn of equity value.

“The large unicorns were mispriced and performed very poorly,” said Kathleen Smith, principal of Renaissance Capital.

WeWork, which scrapped its own listing in September after investors balked at a combination of a high price and dubious governance, has dominated cocktail party chatter. But the downfall of its former chief executive Adam Neumann goes beyond schadenfreude — it has triggered a rethink on valuations.

So far in the fourth quarter, three of four listings have priced below the midpoint of their expected ranges set by underwriters, compared to less than one in three over the first three quarters of the year. The numbers suggest that the likes of Goldman Sachs, JPMorgan and Morgan Stanley have responded to investors’ demands for a better deal.

The shift in sentiment was probably long overdue, said Mr Chung, given that companies losing billions of dollars a year were being handed very high pricetags. “In hindsight it felt like it was getting out of hand and it has been brewing for years,” he said.

The unease coursing through the market for new listings has not completely sapped demand for untested growth companies. Stock in Peloton, the exercise bike start-up, for example, dropped 12 per cent on day one in September, after its bankers priced the deal at the upper limit of its price range, but this week it edged above its listing price for the first time.

The company’s market capitalisation is now about eight times its sales over the past 12 months, a significantly higher ratio than the average 3.6 times in the year Mr Chung bought Netflix. (Netflix is now at about seven times).

However, the recent weakness in new listings has injected a dose of reality — and has presented growth-focused investors like Alger with a set of new opportunities. Many of them recall what happened to Facebook, which was the largest tech IPO in history when it rang the opening bell in May 2012.

The social media group’s shares rose on their first day of trading to close at $45, from $38 at the open, but fell to $21 in the following months. Today, the stock trades at $197.

“I think the recent correction is super healthy,” Mr Chung said. “The risk is being taken out of [new listings] as we speak.” Ms Smith of Renaissance calls it “a buyers’ strike” on the part of fund managers who normally pile in to IPOs.

Ms Smith added that a lull in new listings could easily be followed by a snap back. “I anticipate we will see an awful lot of private companies that are getting their act together, and they will probably be more cautious in how they price their IPO,” she said.

But, for now, the whiff of WeWork’s failure still hangs over the market.

“When something like that happens it’s usually an inflection point,” said Stephen Blitz, chief US economist for TS Lombard. “It tells you smart money is no longer doing stupid things.”

Once popular products are now UK’s worst selling funds group after chronic underperformance

UK funds that promised retail investors positive returns in all markets have been hit by a tide of redemptions, having once been feted as the ideal product for wary savers scarred by the financial crisis.

Absolute return funds, which use a range of assets and derivatives, were promoted on the promise of a set level of returns above cash, in exchange for higher fees than standard equity funds. But after several years of failing to deliver, they have become the worst selling fund group in the UK with £15bn of net outflows over the past 12 months, according to Morningstar data.

“The sector saw an extended period of underperformance from late December last year to June 2019,” said Charles Younes, research manager at FE Investments. “Many of these funds did not have enough protection on the downturn, which made periods of negative performance stand out even more.”

The best-known in the category, Standard Life Aberdeen’s Global Absolute Return Strategies, or Gars, was once Europe’s largest investment vehicle. But its assets have shrunk from £13.7bn to £6.1bn in the past year.

Three years ago the UK Gars fund managed more than £26bn, while the overall strategy — including a Luxembourg version and segregated mandates — had €60bn (£51bn) of assets. Persistent outflows have dogged the £11bn merger in 2017 of Standard Life and Aberdeen Asset Management.

SLA changed the Gars manager from Guy Stern to Aymeric Forest in February, but the move has failed to quell outflows, which totalled £8.2bn over the past 12 months.

The company said performance had improved under Mr Forest and that returns were less volatile than equities.

“Existing clients noted this improvement has persisted and have started to increase their investments,” SLA said. “It will naturally take longer for those not currently invested to be aware of these improvements and to be attracted to the fund.”

Several of the other biggest absolute return funds in the UK market have also suffered heavy outflows. Invesco’s Global Targeted Returns fund dropped by a fifth in that period to £9.9bn having suffered £2.5bn of outflows. BNY Mellon’s Real Return fund also shrunk by a fifth to £6.4bn, mainly due to £2.3bn of outflows.

Clive Emery, multi asset portfolio strategist at Invesco, said the fund had suffered 18 months of poor performance up to last December, but over the past 12 months it had achieved a gross cash plus 5 per cent return. “We expect this recovery in performance, combined with the fund’s positive performance during the market sell-offs in December 2018 and May of this year, to give investors renewed confidence in the strategy,” he said.

BNY Mellon said its strategy had performed strongly in absolute terms, but its UK fund had “not been immune to the more jaded perception of diversified growth funds, with some assets being reallocated into different areas”.

It added: “The picture overseas is somewhat different, where the strategy is less mature and investors adopt a slightly varied perspective.”

Two Aviva Investors absolute return funds have also suffered in the past year. The UK Aviva Investors Multi-Strategy (Aims) Target Return fund has dropped a fifth to £4.3bn due to £1bn of outflows, while the UK Aims Target Income fund fell a quarter to £1.2bn, having bled £500m.

The funds were launched by Euan Munro, chief executive of Aviva Investors, in 2014 after he moved from SLA, where he had been the architect of Gars.

Aviva Investors said it had hired several fund managers to its Aims teams last year. This led to an 8.5 per cent return for the Target Return fund and 10.5 per cent return for the Target Income fund so far in 2019.

“While we experienced outflows earlier in the year, we continue to see interest from new and existing clients and this is translating into an improved outlook for future flows,” it said.

Swiss company looks to restock pipeline with acquisition of The Medicines Company

Novartis is nearing a $9bn deal to buy The Medicines Company, betting that the US drugmaker will come good on a new drug designed to control cholesterol levels, people close to the talks said.

Novartis has agreed to pay around $85 per share, one person said, a sharp premium to the New Jersey-based company’s stock price just days ago when Bloomberg reported that it was exploring a sale.

At $85 per share, the deal would value The Medicines Company at $9.1bn according to analysts at Evercore ISI, which takes into account its fully diluted share count.

The company’s shares closed on Friday at just below $70 each, having jumped from $52 before news of a sale first emerged. The Wall Street Journal reported earlier on Saturday that the companies were nearing a deal.

A takeover would mark the latest attempt by Novartis chief executive Vas Narasimhan to reshape the Swiss pharmaceutical company, which has a market value of $203bn, through a series of disposals and takeovers.

Big pharma companies including Novartis are looking at acquisitions as the primary means of restocking their drug pipelines rather than relying on homegrown research and development.

The Medicines Company earlier this month presented the results of successful late stage trials of its cholesterol-lowering drug Inclisiran. It reduced the so-called ‘bad cholesterol’, suffered by tens of millions of Americans, by up to 58 per cent. The drug is an injection, administered every few months, rather than the current treatment of a statin pill daily.

The drug, which has yet to be approved, works by silencing a gene and reducing a protein that controls the production of so-called ‘bad’ cholesterol. This method of gene silencing — known as RNA interference — has been explored for decades but become more successful in the last couple of years.

The company has partnered on the drug with Boston-based Alnylam Pharmaceuticals, which has received approval for two drugs using a similar mechanism to silence genes, called RNA interference. One, approved by the Food and Drug Administration just this week, treats porphyria, the rare disease which King George III suffered from, and the other, for treating the nerve damage associated with another rare disease, was approved last year.

The Medicines Company is led by Mark Timney, who joined last year after being chief executive of Purdue Pharma, the maker of OxyContin. Before that, he worked at Merck. The Medicines Company, which has just 62 employees, did not respond to a request for comment. Novartis also declined to comment.

Earlier this year Dr Narasimhan said he was aiming to limit M&A spending to about 5 per cent of Novartis’s market capitalisation, as he sought to boost total shareholder returns.

Dr Narasimhan, who since taking the helm almost two years ago has sought to dispose of parts of the company unrelated to its core innovative medicines business, pointed to its acquisition of IFM Tre, a biopharma company focused on immunology, as an example of “a much more focused” acquisition strategy.

Among its key acquisitions last year was the $3.9bn purchase of the French nuclear medicines business Advanced Accelerator Applications and, for $2.1bn, US-based Endocyte — both specialising in targeted radiopharmaceutical cancer treatments. Meanwhile, in cell and gene therapy, an area where the company is a leader, it bought AveXis for $8.7bn, acquiring a treatment for spinal muscular atrophy, a disease for which there is no cure.

However, the company has faced controversy this year, following the disclosure that some data was manipulated from early testing of the spinal muscular atrophy drug Zolgensma. The episode, which the company had been investigating internally, was not publicly disclosed until after the drug had been approved by the Food and Drug Administration. Two senior executives at AveXis were replaced. The FDA approval was unaffected.

Interviewed by the FT in April, Dr Narasimhan made clear that Novartis would be looking for companies that would either help it reap greater rewards from these various technologies, or supplement drugs in the disease areas on which it has already chosen to focus. Dr Narasimhan said: “If it doesn’t fit that framework then we don’t really want to play in it.”

German and French asset managers have redeployed UK-based CEOs back home

Fund management, one of the jewels in the crown of the City of London since the financial crisis, had hoped to escape the worst of Brexit disruption. But mounting evidence suggests that the UK capital’s primacy as an investment management hub may be fading as a result of Brexit.

Global asset managers have already bolstered their teams in continental Europe and transferred billions of pounds of assets to fund centres such as Luxembourg and Ireland. But the latest sign that the UK’s break from the EU is slowly sapping power from London is the recent relocation of several fund industry chief executives to continental Europe.

This month, €557bn fund group Allianz Global Investors replaced its outgoing chief executive Andreas Utermann, who operated from London, with Munich-based Tobias Pross.

The reshuffle mirrored similar moves at several other companies, notably €757bn house Axa Investment Managers, which last month replaced London-based Andrea Rossi with an interim chief executive located in Paris, and €752bn manager DWS, which installed Frankfurt-based Asoka Wöhrmann last year after dismissing Nicolas Moreau, who worked in London.

Though the changes were made for different reasons and none of the asset managers cited Brexit as a contributing factor, they are an indication that UK’s departure from the EU is denting London’s appeal as the nerve centre for asset managers’ international operations.

Amin Rajan, chief executive of Create Research, a consultancy, says that given the stature of the companies involved, the recent executive moves are far from a mere coincidence.

“There is acute uncertainty in the asset management industry about Brexit and the fate of ‘passporting’ arrangements,” says Mr Rajan. “It hangs like the sword of Damocles over every strategic decision.”

There is a tradition of global asset managers locating their CEOs in London in light of the city’s status as a top financial centre. US and Asian investment houses have historically established their European headquarters in the UK capital, seeing it as a gateway to Europe.

Some big European asset managers with parent companies headquartered on the continent also placed senior leaders in London. Santander Asset Management and Candriam Investors Group, which is owned by a US company, continue to be led by London-based CEOs despite the bulk of their business being in the EU.

This structure reflects both the city’s role as a launch pad for companies’ global expansion, as well as its popularity with the bigwigs of international finance. Examples of similar structures abound in investment banking too: Andrea Orcel, until recently head of the investment banking unit of Switzerland’s UBS, carried out his role from London.

From a business perspective, the benefits of London included its large pool of talented investment professionals and international fund salespeople, as well as the large amount of powerful consultants and institutional investors located there.

“London used to be the obvious place for global asset managers to locate their headquarters, but the benefit of basing a business [in the UK capital] is now less obvious with the prospect of Brexit,” says Jean-Louis Laurens, former managing partner of Rothschild & Cie Gestion. “For groups with a parent in continental Europe, the argument for being based in London is basically gone.”

Although the continuation of delegation rights after Brexit has been protected, enabling investment groups to continue to manage funds from London, a question mark hovers over what will happen to passporting — the open relationship on which asset managers rely to sell funds across the EU. The agreement governing the UK’s withdrawal from the bloc contains scant detail on this point.

Mr Rajan says: “London may well remain a major centre for the asset management industry, but the continent will be its growth engine. London’s pre-eminent position may well erode with time, depending on what replaces passporting arrangements.”

But Brexit is not the only factor prompting asset management CEOs to retreat from London. The multiple headwinds buffeting the industry, including declining profit margins and increasing regulatory costs, are leading parent companies to ask hard questions about the future of their fund businesses.

“Some groups are pressing the pause button on their asset management expansion plans,” says Jonathan Doolan, head of Europe, Middle East and Africa at Casey Quirk, the Deloitte-owned consultancy. “They continue to make significant investments in London but they are retrenching a little bit.”

By locating the CEO of their asset management unit closer to home, the parent bank or insurer can exert greater control over the future direction of the business. “Some parent companies want to think about strategy in a much more tied-up way across the group, so it makes more sense for the [asset management] CEO to be located closer to the parent,” says Mr Doolan.

The leadership and location changes at Axa IM and DWS, for example, coincided with a shift in strategic direction for the companies. Parents Axa and Deutsche Bank have instigated cost-cutting programmes at both fund managers, as well as considering selling or merging the businesses with a competitor.

Like most CEOs of international companies, asset management chiefs rarely spend their whole week in one location, spending hours on planes as they shuttle between their company’s different locations.

This roving status is what allowed many fund bosses to remain based in London for so long. During his time at the helm of DWS, Mr Moreau lived in London, where his family was based, but spent several days a week in Frankfurt. Similarly Axa IM and AllianzGI accommodated Mr Rossi and Mr Utermann’s requests to live in London, where they had personal ties, but the two regularly travelled to Paris and Munich.

Frédéric Janbon, CEO of BNP Paribas Asset Management, also lives and works in London, while making weekly trips to the company’s Paris headquarters.

As EU fund groups retreat from the UK, however, US asset managers’ commitment to the country as a base for their European leadership does not appear to be waning.

Jörg Ambrosius, recently appointed as Emea CEO for State Street, the US asset manager and depositary, says: “As of now I have no reason to doubt London’s pre-eminent position. It is still the natural base for the European head of a global financial institution.”

Mr Ambrosius, who works primarily from London while continuing to live in Munich where his family is located, is the legal head of both State Street’s UK and EU entities. He does not foresee this changing with Brexit but admits that a drastic break between the UK and EU could result in the group having to appoint separate leadership teams for the two businesses.

“[Post-Brexit] we will have to see if we need a stronger segregation between entities,” he says.

Roving executives such as Mr Ambrosius will become more common as asset managers wait for the Brexit fog to clear, notes Mr Rajan. “However, if the rise of nationalism remains unchecked, we may well see separate CEOs for the UK and the EU,” he adds. “This could make global asset managers’ operating models more bureaucratic.”

Controversial structures are the ‘scourge of corporate governance’

Institutional investors are fighting back against the prospect of dual-class shares in the UK after Downing Street held exploratory talks about altering listing rules to attract high-growth companies.

The FT reported this month that Number 10 had suggested introducing dual-class shares as part of its efforts to ensure London remains one of the pre-eminent markets to list on after Brexit. The share structures, which are often popular with start-up founders who want to retain significant control, have been used by tech companies including Google, Alibaba and Facebook.

But three big investors have pushed back against the possible introduction of dual-class shares, with one arguing the structures “have been the scourge of corporate governance for some time”.

Rupert Krefting, head of corporate finance and stewardship at M&G, said the British fund house “would be very against encouraging dual-class shares in the UK”, adding it is a “smack against everything the corporate governance code stands for”.

“If you give the founder too much power, it is not a good thing. Just look at WeWork,” he said. WeWork’s dual-class share structure at one point handed Adam Neumann, the property company’s flamboyant co-founder, 20 times the voting power of other shareholders.

Euan Stirling, head of stewardship at Standard Life Aberdeen, said the UK’s second-largest listed asset manager made clear to regulators around the world that it did not support dual-class shares. “Our approach has been absolutely consistent: in our view, it’s a bad idea. We support the principle of one share, one vote,” he added.

Last year, the Singapore and Hong Kong exchanges overhauled their rules to allow companies to list with dual-class shares. Many US companies also have two classes of shares, typically giving more voting rights to one set of investors.

The shares have proven controversial in recent years, however.

Earlier this year, Lyft, the ride-hailing company, was urged by a group of pension funds, unions and asset managers to scrap its proposed dual-class share structure ahead of its initial public offering, but it pushed ahead with the structure when it listed during the summer.

London’s main market is dominated by banks, mining and energy companies, while a host of listed technology companies have delisted over the past decade including Arm Holdings and Autonomy, after being bought by industry rivals or private equity.

Edward Park, deputy chief investment officer at Brooks Macdonald, a wealth manager, said there were examples where dual-class structures allowed a company to think longer term and not react to the vagaries of the market. But he added lack of accountability has typically been a source of more problems than success.

“Listing on the London main market has long been considered a tacit endorsement of the corporate governance of a firm so the UK authorities should think twice before changing their rules to accommodate founder-led IPOs,” Mr Park said. “Being behind the times is seldom a good strategy, however sticking to a strong set of principles normally wins out in corporate governance.”

The Downing Street discussions on dual-class shares come months after the Financial Conduct Authority was heavily criticised by fund managers and trade associations for creating a new category of listing in London that exempted companies controlled by governments from some rules that apply to oligarch-owned and private companies.

Intelsat has had a bad month. Things could get worse from here.

The satellite company’s stock, which closed at $7.11 on Friday, has lost 70% of its value in the past two weeks. Intelsat (ticker: I) now has a market cap of around $1 billion and has $14.7 billion of outstanding debt. Yet Wall Street may still be too optimistic about how much the company could collect from a government sale of 5G spectrum.

The Street assumes that Intelsat, which owns and operates a satellite broadcasting and communications network, will still collect billions of dollars from such a sale. If Intelsat’s take is $5.5 billion, that would justify a share price of $7, according to a sum-of-the-parts analysis from Goldman Sachs. Raymond James thinks it will collect a larger windfall, assigning a price target of $12.

Here’s the background: The U.S. wants to use a range of spectrum called the C-Band as it transitions to 5G. That would involve auctioning part of that C-Band to wireless companies like AT&T (T) and Verizon Communications (VZ). The problem is that eight satellite companies already have the right to use it for TV and radio broadcasts. These companies share the right to use the spectrum, but the rights are nonexclusive and shared, as MoffettNathanson recently said.

Still, a group of satellite companies called the C-Band Alliance, or the CBA, lobbied to run a private sale of that spectrum. Intelsat was set to get 45% of the proceeds under that plan, matching its share of revenue earned in the C-Band.

The expected $25 billion to $30 billion in proceeds may not seem like a lot for the U.S. government, but the three remaining members of the CBA are foreign, and in 2019, that makes for bad politics.

So Federal Communications Commission Chair Ajit Pai has decided on a public auction of 60% of the C-Band. And two senators have proposed legislation that would require the FCC to remit at least 50% of the proceeds to the U.S. Treasury. That is what took the price of Intelsat’s stock to $7 from its price above $25 at the start of this month.

But that $7 price still assumes the company collects 45% of any private-sector proceeds from a spectrum sale, according to Goldman analysts, who put Intelsat’s take at $5.5 billion. Those proceeds would be paid on top of an estimated $3 billion to $4 billion that the government may pay the satellite companies to make up for the cost of vacating that part of the C-Band. Yet the companies may argue that they need more compensation to keep providing the same services to the U.S. on smaller band of spectrum.

Intelsat’s right to use the spectrum is split equally with seven other satellite providers. The providers that aren’t in the CBA are starting to agitate for a change and may ask for the proceeds be split equally as well. “We will continue to work cooperatively with the FCC to develop an effective alternative plan and achieve the best outcome for the American public, while protecting the interests of our users and the rights of our companies,” Intelsat said in a statement.

Eutelsat Co mmunications (ETL.France) has signaled interest in filing its own plan to distribute the proceeds. And the other four small satellite providers with C-Band rights filed a statement opposing the CBA’s plan to allocate the payout according to revenue, the format that would leave Intelsat with that estimated $5.5 billion.

If the satellite providers collect half of the auction proceeds and that sum is split equally, that would imply a 12.5% take for Intelsat, leaving it with a mere $1.5 billion—and probably a much smaller market valuation.

Siemens is busy transforming itself from a dated industrial conglomerate into a modern digital energy, transport, and infrastructure player.

But the Munich-based multinational (ticker: SIE.Germany) is having a tough time. Siemens’ deal with France’s Alstom for a high-speed train merger was blocked by the European Union for antitrust reasons. Siemens shares are at 114 euros ($126), almost the same level as three years ago. The share price is held back by a conglomerate discount that’s estimated at 40%.

Germany’s economy flirted with recession last week, but if Siemens manages to morph into a business focused on digital industries and smart infrastructure, the move could boost earnings. Siemens is spinning off its conventional- and renewable-energy business next year, which is expected to add value.

Two key banks have rated the firm a Buy with targets that are a significant premium to its current price. Bank of America Merrill Lynch’s thinks the stock will rise 18%, to €135, and Citi has a €134 target. In a Nov. 12 note, Citi wrote that the spinoff and “additional commentary on strategic holdings” suggest that the company is positioning itself around digital industries and smart infrastructure. “The proposed cost savings of €2.2 billion in the face of end-market weakness should also provide earnings support,” according to the Citi report.

Siemens posted strong results for the fourth quarter, beating expectations. For the full year to Sept. 30, net income was €5.6 billion on revenues of €87 billion. Citi forecasts that net income could rise to €7.9 billion by 2021.

Joe Kaeser, who has been with Siemens for 40 years and the CEO for more than six, has had a stellar track record cutting costs, restructuring the business, and spinning off divisions. He said in the earnings statement that “the weakening of the global economy accelerated clearly during fiscal 2019.” Still, added Kaeser, “we were again able to underscore Siemens’ performance aspiration with a brilliant fourth quarter. We fully achieved our fiscal-year guidance in all aspects.” He has come under pressure from some institutional investors who tried to block an extension of his employment contract. Chief Operating Officer Roland Busch has been lined up as his eventual successor.

Siemens has a market value of €97 billion and employs 385,000 workers. It started in 1847 when Siemens & Halske Telegraph Construction began doing business in a building behind a courtyard in Berlin. It constructed a pointer telegraph—a small rectangular box weighing about 22 pounds that replaced Morse code by using a needle to point to a sequence of letters. Now the business is in a range of energy, transportation, industrial, and health-care markets and is the world’s largest player in factory-automation equipment.

The company’s future is in digital industries such as computer-aided technology that brings to life virtual plans that automate production lines. Also key is smart infrastructure, which uses the Internet of Things to control smart buildings and seamless payment solutions that can be used on different modes of transport. But much of the value in the next 12 months will come from spinning off the energy business. Wasi Rizvi, an analyst at RBC Capital Markets, recently wrote that the company’s fiscal-year 2020 outlook will see “expected gains in discontinued operations (from the Siemens energy spin), which are expected to offset both a higher tax rate (also owing to the spin) and severance charges in the year.”

This move may help lower and possibly eliminate the conglomerate discount. The true value in Siemens eventually may come from the sum of its parts.

Morningstar’s makeover of its fund medal ratings system this month couldn’t come too soon. Now that investors are flocking to passively managed index funds, research firms that rate actively managed mutual funds must find ways to stay relevant. There was a time when the lion’s share of new money flowing into funds went to active funds that Morningstar rated five stars, but its star system has lost its luster because of the indexing craze.

That may be a good thing. The firm’s star rating is based on a fund’s past performance and volatility, but it hasn’t proved to be very predictive for future performance and volatility. In 2011, Morningstar created a medal ratings system that ranks funds from Negative to Gold based on a more qualitative analysis of managerial skill. That was an improvement, but it also had flaws. It could predict with some accuracy if a fund would outperform actively managed peers in the same investment category, but not necessarily if it would beat its zero-fee benchmark.

The revised ratings system incorporates a zero-fee benchmark hurdle into its analysis. While beneficial to investors, the shift will be painful for many fund managers. Of 556 share classes rated so far under the new system, medal rating downgrades outnumber upgrades by 2 to 1, says Jeffrey Ptak, Morningstar’s head of global manager research. Among share classes formerly rated Bronze, 29% were downgraded to Neutral and 16% were upgraded to Silver.

In the past, a fund’s rating was consistent across all of its share classes for analyst-rated funds. Morningstar would base the rating on the fund’s oldest, most-popular share class, often its lowest-cost institutional one. Now, each share class gets a separate rating, with expenses factored in. As a result, Morningstar effectively downgraded the highest-fee share classes.

A prime example is the $6.3 billion-in-assets A shares of American Funds Growth & Income Portfolio (ticker: GAIOX), which dropped from a Silver rating in October to a Bronze in November (see table). In a new report, Morningstar analyst Leo Acheson writes, “The American Funds Growth & Income target-risk series utilizes impressive underlying strategies. The series’ cheapest share classes receive a Morningstar analyst rating of Silver, while its more expensive share classes earn a Neutral.” The Neutral-rated C class (GAITX) has an expense ratio of 1.42%; the Bronze A shares, 0.68%; and the Silver R5 (RGNFX), meant for 401(k) plans, 0.4%. Previously, all had been rated Silver, despite the fact that the C shares’ higher fees cause it to lag behind the performance of the R5 by a full percentage point a year. American Funds declined to comment.

Morningstar doesn’t factor sales commissions, or “loads,” into its new ratings. This is significant, since funds’ A shares typically carry commissions, while C shares embed sales costs into the underlying expense ratios. This immediately puts C shares at a disadvantage from a ratings perspective. “Our star rating used to have a load adjustment to it,” says Ptak. “But a few years ago, we removed the load adjustment from the rating calculation in view of the fact that loads were so often being waived. The percentage of sales subject to a front-end load with A shares was about 13%.” Perhaps, but for that 13%, the new ratings will be inaccurate.

Previously, the rating was based on five separately rated pillars—Parent, People, Performance, Price, and Process—which were then combined. Now Price and Performance have been wrapped into the other pillars. Ptak says Morningstar will analyze rolling 36-month risk-adjusted returns for funds versus peers and benchmark before and after fees in the Process pillar, to make projections of risk-adjusted returns. This marks a subtle shift. In the past, fees were compared to peers for an absolute Price rating. Now, fees are tied to performance to see what the value add is for them.

The new system has its critics, notably from competing ratings service CFRA, which has always analyzed fund share classes separately and incorporates other factors into its ratings. “Morningstar’s process continues to rely too much on historical performance,” says Todd Rosenbluth, CFRA’s director of mutual fund and exchange-traded-fund research. “It’s trying to predict future returns based on past-performance success, and there’s a reversion to the mean that happens when funds that outperform or underperform in one period tend to move back to the middle of the pack.” Indeed, there is a lot of research regarding this reversion-to-the-mean effect.

CFRA’s ratings are more forward-looking because they analyze a fund’s underlying portfolio, he says. “We’re looking at stocks inside the portfolio and offering a forward-looking 12-month target-price assessment of those stocks to determine if management’s best ideas are likely to succeed.” Still, being forward-looking and predicting accurately are two different things. “We have not published a performance record [for CFRA’s fund rating],” he admits. Until Morningstar’s new system has a longer track record or CFRA publishes its results, the only certainty for investors about what affects future performance is fees.

Everyone loves a good story, and the one investors are telling themselves now is a doozy. The problem? It’s based only partly on reality.

If you believe the current narrative, everything is right with the world. By cutting interest rates three times, the Federal Reserve has averted a recession. And with the U.S. and China slowly making progress on a trade deal, capital spending could revive and boost the economy. And right on time, the S&P 500 index hit a new all-time high, seemingly confirming this rosy narrative.

That is one way of looking at it. But that narrative papers over just how weak the economic data have become. Even worse, investors appear to have thrown caution to the wind as they load up on stocks out of fear of missing out.

Combined, that could be a recipe for a sharp market downturn in 2020.

Yes, ever since this bull market began in 2009, someone has been predicting its demise. Starting with the European debt crisis in 2010, through the U.S. debt-ceiling debacle in 2011 and the devaluation of China’s yuan in 2015, and even after the rate-hike-inspired selloff of 2018, bears would say this is the end. Each time the market rebounded to new highs.

Why is it different now? Chalk it up to an inverted yield curve, one of the markets most reliable recession predictors. The yield curve is said to have inverted when shorter-term interest rates rise above long-term Treasury yields, and is a sign that monetary policy is too “tight.” The possibility of an inverted curve in 2019 was one reason we wrote a Barron’s cover story, “Why the Bull Market Could End in 2020,” in June 2018.

The yield curve remained uninverted through the first 10 years of the bull market, but that changed earlier this year. The market panicked when the curve flipped—but appears to have put the possibility of a bear behind it now that it has uninverted. However, the yield curve predicts trouble 12 to 18 months in the future, says Michael Darda, market strategist at MKM Partners—not an immediate recession. Similarly, a normalized curve isn’t sending an all-clear signal. We won’t know if a recession has been averted until at least this coming summer, according to Darda. “It is simply too soon to know if the soft-landing story will continue to play out,” he says.

If the yield curve works at all. While the yield curve has a near-perfect record of predicting recessions, some have argued that the Fed’s manipulation and foreign demand have undermined its usefulness.

That may be true. Yet signs that the rate increases have had an effect are starting to show up in the economic data. The Conference Board’s leading economic indicators index rose 0.3% year over year in October, its slowest pace since June 2016. Even worse, the U.S. economy looks set to grow by just 0.4% during the fourth quarter if the Atlanta Fed’s GDPNow model is correct.

The market’s hope is that the U.S. and China can reach a trade deal, and that companies, which have cut capital spending by 1% over the past year, will finally boost it again. That may be wishful thinking, and not just because a deal is far from assured. The Fed’s rate increases in 2018 almost certainly dampened capital expenditure, and the 2020 presidential election could be another risk that prevents it from accelerating, says Torsten Sløk, chief economist at Deutsche Bank.

And if companies are afraid to spend, they could stop hiring, too. Already, the job openings and labor turnover survey—better known as Jolts—has declined, falling to seven million in September, the most recent month the data were available, from a high of 7.6 million in November 2018. “Businesses don’t cut back on capital spending without cutting back on other things,” says David Rosenberg, chief economist at Gluskin Sheff.

Strangely, market sentiment appears to be getting better even as the economic data appear to be getting worse. Some $32.5 billion has been put into equity funds over the past three weeks ending on Nov. 13, the most since February 2018.

It wouldn’t be the first time that investors had mistakenly bet on a soft landing. In the run-up to the financial crisis, investors assumed that Fed rate cuts in 2007 and 2008 had prevented subprime-mortgage issues from causing a recession.

That isn’t to say that another financial crisis is in the offing, only that narratives can be misleading. And even many bulls would agree that an unexpected event that would simply ding an economy growing at 3% to 4% could force one growing at 1% to 2% into recession.

“A negative signal from some exogenous factor will cause a bigger impact at this stage in the cycle than at an earlier point,” says Carmel Wellso, director of research at Janus Henderson Investors, who makes clear that her base case is for continued growth and a rising stock market.

Indeed, there’s a good chance that it can keep rising despite the risks, especially if investors keep pouring money into the market. Dow 30,000, remember, is only 7% away.

And that puts investors in a predicament. How do you stay invested for possible upside while preparing for what could be the end of the bull market?

MKM’s Darda recommends buying health-care stocks, which have underperformed in 2019 because of political risks. With the S&P 500 Health Care Sector Index trading at 16 times forward earnings, below the S&P 500’s 18 times, they’re the cheapest of the defensive sectors.

Rosenberg, who is leaving Gluskin to start his own firm, recommends buying companies with strong balance sheets, businesses that don’t rely on strong economic growth, and that don’t need to refinance debt. He also recommends buying stocks with strong dividend growth, ample free cash flow, and low payout ratios. “You want to focus not so much on what sectors you want in, but which companies you want to be in,” he says.

If you want to be in any at all.