Barrons weekend summary: Positive feature on BA and on US steel industry
* Cover story: Regardless of how U.S.-China trade talks play out, the global system of trade is being realigned as a decades-long drive toward free trade across borders begins to reverse and globalization increasingly becomes overwhelmed by populism, nationalism, and protectionism.
* Features: 1) Positive on BA: Previous crashes involving the aerospace giant’s planes have sent shares down, only for the market to see them rise again, precedents today’s shareholders can look to as a reason not to panic about the recent Ethiopian Airlines Max jet crash—though they shouldn’t count on a quick recovery; 2) Positive on NUE, STLD, X, CMC: Shares of the four leading U.S. steel producers trade well below historical averages, and given the industry’s volatile history, investors should be cautious on the stocks—among potential catalysts is the fact the U.S. is short of steel production and needs imports to satisfy demand, making imports the price setters; 3) Members of Barron’s 2019 energy roundtable say certain integrated oil-and-gas companies are poised to benefit as projects long in the planning finally come on-line, and they don’t foresee a big surge this year in oil prices—though $60 crude shouldn’t hamper well-managed companies.
* Tech Trader: Cautious on SQ: Company was among the first to see an opportunity helping small businesses accept credit-card payments, but its move into lending, cryptocurrencies, and software raises the question of whether it should leave its roots behind and become part software provider, part bank.
* Trader: Though much of the recent economic data has been weaker than expected, Torsten Sløk of DB says he sees very early signs of a possible recovery in both the economy and corporate earnings; Solar demand is back on the upswing, and solar stocks have already responded—TAN is up 30% this year, nearly erasing all of its 2018 drop; There are several factors working in favor of small-cap stocks, which still look cheap relative to large-caps, says Lori Calvasina of RBC Capital Markets.
* Profile: Natasha Sibley, co-manager of the $250M AlphaGen Castor Fund at JHG believes that European stock dividends are trading too cheaply and that a surer way to make money amid the political uncertainty is to capitalize on the discrepancy between the price of European stock dividends.
* European Trader: Positive on Phoenix Group Holdings: Brexit-weary investors in European stocks might want to take refuge in the firm—which acquires closed lines of pensions and life insurance and winds down the books of business—whose shares have limited downside and the potential for lasting income.
* Emerging Markets: After a strong January, emerging market stocks are once again underperforming their U.S. peers, but conditions remain ripe for a further rally in the sector as macro risks that have frightened investors appear to recede.
* Commodities: Oil is among the biggest commodity gainers in 2019, with prices up by more than 20%—but cuts may run head-on into the effects of increased U.S. shale production and more output from other sources.
* Streetwise: Columnist Jack Hough comments on the recent college-admission scandal, noting that anyone with a reasonable shot of completing a college degree should do so—but the fact that so many kids will lose money on a product that ought to be cheap is the real scandal about which people should be concerned.
Why US equities may yet have the last laugh
Although the S&P 500 looks expensive versus rivals, it has plenty running in its favour
Equity investors are renowned for their optimism, or what a curmudgeonly bond trader would view as a combination of ignorance and confidence.
Major government bond and equity markets reflect contrasting outlooks for the world economy. The rebound in equities, credit and commodities such as oil, suggests a reassurance that growth will overcome a soft patch and gain altitude later this year.
The message from government bonds is different. With the amount of global negative-yielding debt back above $9tn and at the highest since late 2017, bond investors are less confident that the growth and inflation expectations of leading central banks will materialise.
Given this dissonance between the two major markets, it is understandable that plenty of investors are reluctant to chase this year’s rebound in equities. One important caveat is that money has flowed into China, before and after MSCI added more of the country’s stocks to its flagship emerging market index. China’s ranks of retail bulls have been rewarded by the power of indexing.
Analysts at Société Générale have focused on where money is flowing, and this week note that “equities have risen the most in decades, but outflows from the equities asset class have been significant, caused by last year’s damage to portfolios”.
This chimes with the money leaving US equity exchange traded funds this year, with the latest tally of outflows pegged at $17.6bn, according to XTF.com. That leaves buybacks supporting Wall Street.
The lack of clarity over what a US-China trade deal might look like makes hugging the sidelines even more appealing for investors. For all the optimism suggested by the world-beating performance of Chinese equities this year, there is precious little detail on whether the world’s two biggest economies can settle their differences.
Indeed, defensive positioning in equities, alongside slumbering bond yields, suggests fund managers are wary that 2020 could prove tough. At the heart of this fear is whether a slowing US economy finally brings the performance of Wall Street stocks back into line with a less spectacular showing from the rest of the world in recent years.
One of the most striking features of the past decade has been the leadership of US stocks, with the S&P 500 eclipsing its global rivals. Using 12-month forward earnings, US equities look expensive versus the rest of the world. The S&P 500 trades at 16.8 times 2019 estimates, while the FTSE All-World index, excluding the US, is at 12 times. It is a gap that has been growing over the past five years, reflecting how the S&P 500 has been turbocharged by tech stocks just as struggling financials hinder other developed and emerging world equity markets.
Given the large presence of banks in the eurozone equity market, for example, it is hardly surprising that investors have shunned the region over the past year. There is little that would encourage investors to wade back into the water given the extended outlook of low government bond yields and a eurozone economy reliant on global demand picking up.
Certainly the Stoxx banks index stands out as a cheap sector judged by its book value. It has not been above 1 since 2007, but that is precisely because the industry is so challenged.
Which brings us to a key question of whether expensive US equities should be shunned in favour of other “cheaper” markets. Another point of comparison between Wall Street and its rivals, including MSCI’s EM index, is their return on assets, and here the S&P 500 had a hefty advantage.
Nicholas Colas at DataTrek reckons US equities justify a higher valuation because the companies have better earnings growth prospects and benefit from “future technological innovation that defends and expands competitive advantage”. One can quibble over whether that justifies the full valuation premium the S&P 500 commands, but Mr Colas holds to a “longstanding recommendation to be overweight US equities in global portfolios”.
While the US valuation premium sticks out, and rightfully raises fears that Wall Street faces a major reckoning, it needs to be placed in a wider context. The backdrop of low interest rates may well stem the extent of any reversal, allowing equities to eclipse fixed income returns over the coming decade.
As Capital Economics argues: “The real return from US equities in the coming decade could plausibly be less than a third of what it has been in the last 10 years (the average annual real return since 2009 has exceeded 15 per cent)” and still top the returns from other assets, notably Treasury bonds.
Given the low levels of Treasury yields leaves their returns after inflation close to zero, US equity investors may well enjoy the last laugh over both a global stock portfolio and government debt.
Why the 737 That Crashed Is Boeing’s Best-Selling Plane Ever
The way we fly has changed dramatically over the last 30 years. Jumbo jets are losing favor and being replaced by planes like the Boeing 737: smaller, fuel-efficient aircraft capable of traveling greater distances.
Now, nine out of every 10 passenger flights in the United States are on these smaller planes. They have an engine under each wing, often single-aisle cabins and perhaps less legroom than you’d want.
The recent crash in Ethiopia involved a Max 8, one of the latest in the 737 line, which has become the industry’s workhorse. There are a half-dozen types of the plane, and competitors like Airbus have their own popular models. Southwest flies the 737 exclusively and has more than 30 Max 8s.
Based on preliminary evidence, officials have suggested that a flight stabilization system could have been involved in the accident, which bore striking similarity to last year’s Lion Air crash of another Max 8. Earlier models of the 737 do not come equipped with the system.
The repercussions of the accidents could endanger a big moneymaker for Boeing. There are thousands of Maxes on order, according to the company.
The shift to smaller planes over the last generation was driven partly by technological advancements: Giant planes were no longer the only ones that could fly fast enough or hold enough fuel for long journeys.
The shift was also a result of changing demand. As the American population grew, more people began flying. They increasingly sought out longer, direct flights over shorter trips that involved layovers at congested airports.
By 2011, airlines began placing orders for the latest version of the 737, the Max 8. It was billed as having better fuel efficiency and more advanced technology. The Max, which starts at around $100 million per plane, quickly became Boeing’s best-selling model.
After two versions of the Max — the 8 and 9 — were grounded earlier this week, Boeing on Thursday said that it would temporarily halt deliveries of the plane.
The outstanding orders represent almost a half-trillion dollars in revenue for the company over the coming years.
New Evidence in Ethiopian 737 Crash Points to Connection to Earlier Disaster
Investigators at the crash site of the doomed Ethiopian Airlines flight have found new evidence that points to another connection to the earlier disaster involving the same Boeing jet.
The evidence, a piece of the Boeing 737 Max 8 jet that crashed in Ethiopia last weekend killing 157 people, suggests that the plane’s stabilizers were tilted upward, according to two people with knowledge of the recovery operations. At that angle, the stabilizers would have forced down the nose of the jet, a similarity with the Lion Air crash in October.
Although the crash investigations are still in the early phases, the new evidence potentially indicates that the two planes both had problems with a newly installed automated system on the 737 Max jet intended to prevent a stall.
This evidence ultimately contributed to American regulators’ decision to ground the 737 Max this week, according to the two people who spoke on the condition of anonymity. The Federal Aviation Administration said it had found physical evidence from the Ethiopian crash that, along with satellite tracking data, suggested similarities between the two crashes.
As the investigations continue, Boeing has also been racing to finish a software update for the 737 Max aircraft, which is expected by April. Boeing and the Federal Aviation Administration have continued to stand by the safety of the plane. Yet Boeing’s update will modify features of the jet around the automated system that investigators have suggested might have played a role in the Lion Air crash.
The new evidence found at the crash site in Ethiopia, a piece of equipment known as a jackscrew, controls the angle of the horizontal stabilizers. The stabilizers can be triggered by the automated system, known as MCAS.
The stabilizers could have been tilted upward for other reasons. Authorities in France are analyzing the black boxes of the Ethiopian Airlines plane for more information.
Indonesian and American authorities are also looking into whether MCAS contributed to the Lion Air crash that killed 189 people in October. In that disaster, the automated system, possibly based on faulty sensor readings, may have repeatedly pushed the nose of the plane down, creating a struggle between the new flight control system and the pilots.
After the Lion Air crash, Boeing backed the safety its planes and 737 Max aircraft continued to crisscross the planet. In the background, Boeing has been working on a software update for the planes.
Boeing designed the 737 Max as an updated, more fuel-efficient version of its best-selling 737 aircraft. The Max’s engines were bigger and mounted farther forward on its wings, a configuration that could push the nose upward toward a stall in certain circumstances. To compensate for that, Boeing installed MCAS to automatically push the nose down to counteract those forces, in the hopes of making the 737 Max safer and able to handle like its predecessors.
That similarity was part of Boeing’s pitch to the F.A.A. and airlines: Because the plane handled like previous 737s, pilots would not need to be retrained to fly it. Regulators and carriers agreed, and the pilots’ 737 Max training typically amounted to a course on an iPad and a few white papers.
The automated system, which may have pushed down the nose of the aircraft in the Lion Air crash, activates if just one of two sensors mounted on the aircraft’s exterior says the nose is too high. That means a single malfunctioning sensor could force the plane in the wrong direction, as has been theorized in the Lion Air crash.
Boeing is updating the software to require data from both sensors for the system to kick in, according to pilots at several major airlines and two lawmakers briefed on the matter.
Modern aircraft are built with backups and redundancies for virtually every crucial component. So when something breaks — as things often do — it won’t threaten the safety of a flight. Boeing’s software fix indicates that the plane maker shipped the 737 Max with a single point of failure, a potentially dangerous anomaly in aviation, and the Federal Aviation Administration approved it.
Such a single point of failure on a modern jet is rare and far riskier than having backup systems, said Michael Michaelis, the top safety official at American Airlines’ pilots union and a 737 captain. “A single point of failure on a significant system that points my nose towards the ground?” he said. “Now that to me seems just a little bit over the line.”
Boeing has also said its software fix would cause the automated system to push the nose down at a slower rate, Mr. Michaelis said. The system currently pushes the nose down by 2.7 degrees in 10 seconds, Mr. Michaelis said. “That’s a pretty aggressive pitch down,” he said, particularly just after takeoff.
The update will also deal with another concern in the wake of the Lion Air crash: pilots fighting with MCAS.
Investigators have said it appears that the Lion Air pilots repeatedly pulled the plane’s nose back up after the automated system pushed it down. This continued until it was too late and the aircraft slammed into the Java Sea.
The system is designed to push down the nose of the aircraft if sensors are saying it is necessary — overriding what pilots may be trying to do. The software update would limit the number of times MCAS tries to push down the nose, preventing it from struggling with a pilot, according to the pilots.
Boeing has indicated the software fix will “make an already safe aircraft even safer.” The F.A.A. has said it expects to tell airlines “no later than April” to incorporate the software fix.
Pilots at American Airlines, Southwest Airlines and United Airlines said they still generally felt comfortable flying the 737 Max jets, in part because they are now aware of the automated system. Boeing did not fully disclose the system to pilots until after the Lion Air crash.
Reviews of tens of thousands of 737 Max flights at American, Southwest and United showed the automated system never activated, presumably because their pilots never forced the noses of their aircraft too high. Some pilots said they were concerned the system could be activated by a single inaccurate sensor, pushing the plane toward the ground right after takeoff, when the margin for error was thin. But they added that in that situation, they could always flip a switch to automatically turn off systems like MCAS.
“It is of course a concern for pilots,” said James LaRosa, a United Airlines’ 737 pilot. “But if it happened to me or our pilots, I know that our pilots would react.”
'Delete Facebook' - WhatsApp Co-Founder Slams "Capitalistic Profit Motive" Behind Data Scandals
Whatsapp cofounder Brian Acton told an undergraduate class at Stanford University on Wednesday to delete Facebook from their lives - telling students at his alma mater that the social media giant sold its users up the river in a profit-driven orgy of data privacy violations, according to BuzzFeed.
"The capitalistic profit motive, or answering to Wall Street, is what’s driving the expansion of invasion of data privacy and driving the expansion of a lot of negative outcomes that we’re just not happy with," said Acton.
"I wish there were guardrails there. I wish there was ways to rein it in. I have yet to see that manifest, and that scares me."
Acton - who was made a billionaire several times over when he sold WhatsApp to Facebook for $19 billion in 2014, defended the decision. Despite having reservations, Acton says he had to consider his employees, his investors, and his own stake in the company.
“You go back to this Silicon Valley culture and people say, ‘Well, could you have not sold?’ and the answer is no,” he said, referring to his decision to make the “rational choice” to take “a boatload of money.""I had 50 employees, and I had to think about them and the money they would make from this sale. I had to think about our investors and I had to think about my minority stake. I didn’t have the full clout to say no if I wanted to,” he continued. -BuzzFeed.
Then, after the Cambridge Analytica data harvesting scandal broke, Acton became publicly vocal - tweeting in March 2018 "It is time. #deletefacebook"
Wednesday's appearance marks the second time Acton has publicly spoken about the deteriorating relationship he had with Facebook and its CEO Mark Zuckerberg. In September of 2018, Acton told Forbes "I sold my users’ privacy to a larger benefit." Acton goes on to describe how Facebook wanted to aggressively monetize WhatsApp to a run rate of $10 billion within five years by pushing ads and offering businesses methods to directly reach Facebook users.
Acton explained that he was naive at the time he sold - thinking that he and follow cofounder Jan Koum could continue doing things "their way" by diversifying revenue in other ways that did not include taking advantage of users.
He said he pushed for a service model, possibly by charging WhatsApp users a small fee to use the app, as the company did in its early days, to counter Facebook’s traditional revenue driver: advertisements. Instead of sucking up user data to help advertisers target ads, Acton and Koum hoped a service model could align their interests with the users’ need for privacy and security. -BuzzFeed.
"WhatsApp’s business model was: We’ll give you service for a year for a dollar," said Acton. "It was not extraordinarily money-making, and if you have a billion users … you’re going to have $1 billion in revenue per year. That’s not what Google and Facebook want. They want multibillions of dollars."
On Thursday, hours after the New York Times reported that Facebook is now under criminal investigation over its data deals, Zuckerberg wrote in a blog post that Chris Cox, Chief Product Officer, and Chris Daniels, CEO of WhatsApp, had decided to leave the company.
Maybe letting appmakers sell the private details of unsuspecting users to the highest bidder just isn't sitting well with some people?
Questions about policing online hate are much bigger than Facebook and YouTube
In the wake of a hate-fueled mass shooting in Christchurch, New Zealand, major web platforms have scrambled to take down a 17-minute video of the attack. Sites like YouTube have applied imperfect technical solutions, trying to draw a line between newsworthy and unacceptable uses of the footage.
But Facebook, Google, and Twitter aren’t the only places weighing how to handle violent extremism. And traditional moderation doesn’t affect the smaller sites where people are still either promoting the video or praising the shooter. In some ways, these sites pose a tougher problem — and their fate cuts much closer to fundamental questions about how to police the web. After all, for years, people have lauded the internet’s ability to connect people, share information, and route around censorship. With the Christchurch shooting, we’re seeing that phenomenon at its darkest.
The Christchurch shooter streamed video live on Facebook and posted it on other platforms, but his central hub was apparently 8chan, the image board community whose members frequently promote far-right extremism. 8chan had already been booted from Google’s Search listings and kicked off at at least one hosting service over problems with child pornography. (8chan’s owner claims the site “vigorously” deletes child porn.) After the shooting, some users posted comments speculating that the site would be taken down. Forbes later raised the question of somehow shuttering 8chan, and in New Zealand, internet service providers actually did block it and a handful of other sites.
The past couple of years have seen a wave of deplatforming for far-right sites, with payment processors, domain registrars, hosting companies, and other infrastructure providers withdrawing support. This practice has scuttled crowdfunding sites like Hatreon and MakerSupport, and it’s temporarily knocked the social network Gab and white supremacist blog The Daily Stormer offline.
Companies that aren’t traditional social networks still have systems for scrubbing objectionable content. One user on 8chan’s subreddit pointed readers toward a Dropbox link with the video, but a Dropbox spokesperson told The Verge that it’s deleting these videos as they’re posted, using a scanning system similar to the one it uses to detect copyrighted work.
It’s hard to take a site down permanently, though, thanks to the plethora of companies providing these services — an element of the open web that’s generally considered a good thing for the ways it removes traditional gatekeepers. The Daily Stormer quietly came back online after several bans, and Gab received very public support from a Seattle-based domain registrar. There are also decentralized protocols designed specifically to keep content online. As of this afternoon, the troll haven Kiwi Farms was linking to a BitTorrent file of the video — something that doesn’t require hosting on any kind of central platform.
Infrastructure companies can be more reticent to get involved with content policing than Facebook or Twitter. Cloudflare, which helps protect sites against denial-of-service attacks, has explicitly taken a hands-off approach. “We view ourselves as an infrastructure company on the internet. We are not a content company. We don’t run a platform or create content or suggest it or moderate it. And so we largely view our point of view as one driven by neutrality,” says Cloudflare general counsel Douglas Kramer.
Kramer compares Cloudflare policing content to a truck driver making editorial decisions about what a newspaper prints before transporting it. Cloudflare complies with court orders and won’t deal with companies on official sanctions lists. In one high-profile incident, the company also banned The Daily Stormer for suggesting that Cloudflare had endorsed its white supremacist ideology and harassing critics who filed abuse reports. “They were pretty unique in their behavior,” Kramer adds, and the company hasn’t dealt with a similar case since then.
In a breakdown of its policies published last month, however, Cloudflare urged countries to develop mechanisms for fighting “problematic” material online — arguing that despite concerns about preserving freedom of speech and due process, governments have a kind of legitimacy that web platforms making unilateral decisions do not.
Even without new laws, we could potentially see country-wide blocks on 8chan and similar sites. But that would be an extreme measure that would give either ISPs or governments a huge amount of power over the internet. (In the US, Verizon did briefly ban 8chan’s predecessor 4chan in 2010, but it was supposedly related to a network attack, not 4chan’s content.) There’s a big gap between making somebody leave Twitter or Facebook and start their own website, and exerting control over everything that can be seen or posted on the web.
And it’s possible that a site like 8chan would be mostly quarantined if larger social media networks scrubbed site links and official accounts, making it harder to get traffic like a recent boost from game studio THQ Nordic, which promoted an 8chan AMA on its Twitter account last month. That would be controversial — but far less so than trying to completely pull a site or a piece of information offline for good, especially without having some hard conversations about how we want the internet to work.
As China Faces Slowdown, Stimulus Will Have Smaller Global Reach
Economic growth since financial crisis means large-scale tax cuts and spending won’t accomplish as much as they used to
BEIJING—China’s spending spree during the global financial crisis helped pull the world economy out of recession. This time, Beijing’s stimulus might not pack the same punch.
China’s leadership is adopting what some traders dub a “cocktail approach” to arresting its economic slowdown. Its remedies include a mix of greater deficit spending, tax cuts and easier credit.
In a national address in early March, Premier Li Keqiang announced the government will cut taxes and fees for businesses by a total of 2 trillion yuan ($298 billion), or 2% of China’s $13 trillion economy. That includes reductions in value-added taxes—which hit products as they move from raw material to finished goods for sale—and required corporate contributions to pensions.
The scale of the reduction exceeded market expectations. Mr. Li also announced big-ticket spending initiatives, including an investment of 800 billion yuan in railway construction and 1.8 trillion yuan to build roads and waterway transportation.
The tax-cut and spending measures add up to 4.6 trillion yuan to the economy, exceeding the 4-trillion-yuan pro-growth package Beijing rolled out in late 2008. However, China’s economy has become bigger since then, meaning a similar amount of stimulus doesn’t go as far as it used to go. The 4-trillion-yuan package represented 13% of China’s GDP in 2008—and that doesn’t count a massive lending spree that accompanied the spending—and less than 5% now.
“Whether China’s stimulus still has a big impact, or how big an impact it will have for the rest of the world, mostly depends on how large the stimulus is,” says Wang Tao, chief China economist at UBS Group. Relatively speaking, the stimulus then was much bigger, she said.
Another metric of stimulus is the expansion of China’s so-called augmented fiscal deficit, which takes into account the government’s own spending and spending funded by government-controlled financial firms. By that measure, UBS’s study shows that China’s stimulus this time is much smaller than the one launched during the financial crisis. Such deficit spending is expected to increase by as much as 1.8 percentage points in 2019 from last year, compared to a jump of 9.6 percentage points in 2009 from 2008.
Behind the more modest growth push is a realization in Beijing that China’s traditional debt-driven growth model has reached its limit. Mr. Li, the premier, and other senior leaders have time and again sworn off what was known as “flood-irrigation stimulus” in the past.
According to an analysis by Ms. Wang and her team, overall credit growth—including bank loans, corporate bond issuance, local government bond issuance and other debt—will accelerate to 11.5% as of the end of this year from about 9.5% at the end of 2018. By contrast, China’s credit jumped 36% in 2009 after an 18% increase a year earlier.
By 2018, total debt outstanding of companies, central and local governments, and households hit nearly 250% of gross domestic product in 2018, up from less than 150% a decade earlier. Debt growth like that is dangerous, the International Monetary Fund has warned repeatedly. In a January 2018 report, for instance, it noted nearly every case of credit boom similar to China’s was followed by “a major growth slowdown or a financial crisis.”
Total debt of U.S. companies, households, and federal and local governments, by comparison, was 247% of GDP in 2018, with a big spurt in household debt coming in the years before the 2007-09 housing crisis.
Most of China’s debt growth comes from state-owned companies and finance firms controlled by various levels of government, which often use the money to fund projects that are politically appealing but not always commercially viable.
China is getting less output from its borrowing than before. In 2008, according to a report issued last summer by the IMF, 1 trillion yuan of credit was required to generate one trillion yuan of economic output. In 2017, the most recent year for which such data is available, 3.5 trillion yuan of credit was needed for the same scale of GDP creation.
China has improved the efficiency of its credit use in the past three years, thanks to the government’s effort to cut industrial overcapacity and stabilize debt levels. The IMF study shows the 2017 credit-intensity figure was a marked improvement from the levels in the previous two years and predicts more progress in the years ahead.
But to stabilize the country’s overall debt levels, according to the IMF, Beijing will have to speed up revamping its lumbering state sector and carrying out other market-oriented reforms that could lead to more efficient allocation of credit and other resources.
The U.S. is asking China to reform its state sector too, but President Xi Jinping, who sees the state sector as a foundation for party rule, has moved in the other direction, making state companies bigger and strengthening state control over the economy through them.
The constraint from already-high debt levels explains why the nature of Beijing’s pro-growth package is changing from the financial-crisis era—from credit to tax cuts and government spending.
The shift might not be potent as quickly as past efforts: Ms. Wang thinks companies are likely to keep most of the saved taxes rather than spend it, in light of the slowdown and uncertainty caused by the U.S.-China trade tensions.