Political Developments

 

The outcome of the elections in France calmed concerns at the European headquarters and the Euro strengthened as a result. There are justified hopes that the necessary economic re-forms will now be tackled and that industrial production and the labor statistics will improve.

 

However, ongoing provocations by North Korea increased tensions with South Korea, Japan and the United States and these uncertainties will continue to overshadow financial markets.

 

 

Anticipated future Monetary Policy

 

At the end of June, comments from council members of the ECB, and the governors of the Bank of Canada and the Bank of England suggested that a tightening of the money supply is nearing. In their views, the global economy has gained satisfactory momentum to warrant a «see through» stance while the actual inflation rate remains below the target rate of 2% in several European countries. Weaker energy prices of the past six months were seen as a temporary phenomenon. At the same time, the FED inched up US rates by another ¼% to 1% and 1¼%.

 

 

Underestimated bond risks

 

It was obvious that leading bond markets reacted negatively to the anticipated change of monetary policy and yields increased accordingly.

 

Following Ireland and Mexico, an Argentinian bond in USD with a term of 100 years was offered late June at the rate of 7,125%. While an amount of USD 2,75 billion was sought and accepted, total subscriptions reached the sum of USD 9,75 billion. Investors should have been reminded that over the last 200 years, Argentina defaulted eight times on its debt but the temptation of an attractive interest rate was so great that the credit risk involved was ignored. Recently several doubtful borrowers took advantage of the favourable investment climate to raise capital at terms that do not meet acceptable investment criteria. At this stage of the cycle, careful analyses of the credit risk of each issue is paramount. In case of doubt it is advisable to abstain.

China is liberalizing investments in CNY-bonds through «Bond Connect», a platform based in Hong Kong that will gradually enable international investors to invest in fixed rate securities of Chinese borrowers. Back in 2014, a bridge to the mainland share markets of Shenzhen and Shanghai was established via Hong Kong that has worked rather well since.

 

 

Currencies & Commodities

 

Leading currencies remained reasonably stable during the quarter and the most notable change was the strength of the Euro vs. the USD, GBP and CHF.

Among commodities, cobalt and lithium advanced while crude oil declined.

 

 

Equity market performance

 

As illustrated by the following comparison, the U.S. markets continued their advance during the second quarter,  strongly  supported  by a  few momentum  stocks,  that will be  commented  on  in one of  the following paragraphs:

	31.12.2016	31.03.2017	30.06.2017	%change Q1.	%change 2017
DJIA	19763	20663	21350	4.55	8.03
S&P	2239	2363	2423	5.54	8.22
Nasdaq 100	5383	5912	6140	9.83	14.06
FTSE 100	7143	7323	7313	2.52	2.38
DAX 30	11481	12313	12325	7.25	7.35
SMI 20	8220	8659	8907	5.34	8.36
CAC 40	4862	5123	5121	5.37	5.33
Euro-Stoxx	3291	3501	3442	6.38	4.59
Nikkei 225	19114	18909	20033	1.07	4.81
SSE Comp. (China)	3103	3223	3191	3.87	2.84
JSE All Share (SA)	72496	76744	78213	5.86	7.89

 

In  the  context  of  the performance  of  the  Nasdaq  100  Index,  the following  comparison shows how market capitalization of the world’s leading companies has shifted from Japan to the United States since the Nikkei 225 peaked in 1990:

 

	01.01.1990		01.01.2017
1	NTT	Japan	Apple	USA
2	Exxon Mob.	USA	Alphabet	USA
3	General Electric	USA	Microsoft	USA
4	Tokyo Electric Power	Japan	Berkshire Hathaway	USA
5	IBM	USA	Amazon	USA
6	Toyota	USA	Facebook	USA
7	Royal Dutch Shell	NL	Exxon Mob.	USA
8	Nomura	Japan	Johnson & Johnson	USA
9	Bank of Japan	Japan	JP Morgan Chase	USA
10	Altria	USA	Wells Fargo	USA
11	Nippon Steel	Japan	Samsung	Korea
12	Panasonic	Japan	General Electric	USA

 

Of the world’s top 100 companies, 55 are presently based in the U.S., 22 in Europe and 11 in China.

These changes are the result of synergies available in a liberal business environment. A good education system, inventiveness, abundance of venture  capital and  the  determination  of  some very talented entrepreneurs in the U.S. have enabled this in the first place.

 

But the fact that there are presently so many US names on the list of companies with the highest global market capitalization may also suggest that the US market may be similarly overvalued today as the Japanese market was in 1989/90.

 

 

Outlook for Equity Markets

 

At the Meeting in April, it was felt that markets needed to consolidate the strong gains of the previous two quarters before the rally could continue. This turned out as largely correct, except that the stocks with the largest capitalization listed earlier continued their surge to new highs and due to their strong weighting drove the relevant indices even higher. Alphabet and Amazon breached the USD 1'000 mark temporarily but gave up some of the recent gains at the end of June. Amazon expanded into the food sector and surprised with strong market share gains to the detriment of the traditional retailers.

 

From Berkshire Hathaway, we know that over the long term, value stocks performed better than high growth shares.  Since 2011, the tide has turned and fast-growing companies have outperformed companies that trade near or below book value by a handsome margin.

 

Facebook, Alphabet, Amazon and Apple are generating the earnings or are disposing of sufficient liquid assets to  support  the  high present valuations,  but Netflix  and  Tesla among  others lost  all  the  gains made during the last qtr. again towards the end of June. Any down day should be regarded as a first entry point (50%) for Amazon, Facebook or Alphabet. Two to three months later, the initial positions should be completed irrespective of then prevailing prices.  

 

Preference must be given to companies with good earnings transparency in the U.S. as well as Europe and the U.K.  Alternatives  to  equities  are  hard  to  find  and  investment  decisions  should be  based  on companies with strong and stable earnings prospects.

 

Barring unforeseeable events, favourable market performance in the U.S. and a resumption of the up-trend in Europe is likely over the coming months.

 

Commodities & Precious Metals–Implications for the car industry

 

Between 1st January and 30th June 2017, the ounce of gold rose from USD 1'151 to USD 1'241. Platinum appreciated marginally from USD 902.50 to USD 925.50.

Brent crude fell from USD 56.75 / barrel to USD 48.93 during the same period.

 

However, Cobalt rose from USD 15/lb. at the end of December 2016 to USD 27/lb. at the end of June, more than any other commodity. Over the past six months lithium rose further from USD 91/lb to USD 109/lb.

 

Cobalt is applied in the cathodes of lithium batteries and with the start of production of Tesla’s model 3 on 7. July, a temporary shortage of batteries became apparent that drove cobalt and lithium prices even higher. With over 400'000 pre-ordered Model 3 cars offered at the price of USD 35'000 each, it remains  to  be  seen  whether  Tesla  will  become  profitable as  planned  next  year. Continuously rising prices for cobalt, lithium and rare earths which are also required, could jeopardize the original financial plans. During the 2nd qtr. 2017, Tesla built22'000 cars and missed the 25'000 quarterly target once more. On this news, Goldman Sachs lowered the target price for the shares of Tesla to USD 180.After reaching a high of USD 383 on 25. June2017, the price dropped to USD 313 two weeks later.

 

In China, Tesla’s main competitor Geely announced that it is likely to sell as many as 1,1 million electric cars during the current year, an increase of 89% over the previous year. Geely has further said that its Swedish manufacturer Volvo will switch to hybrid/electric cars exclusively from next year. From 2019, all German car companies will introduce their own electric models as well. In fuel-driven cars, platinum and palladium is used in catalysts. These precious metals will no longer be required with the replacement of combustion engines in the car industry. It is now obvious, that the transition to electric and self-driving cars cannot be stopped. This will lower the consumption of fuel over time. Aviation, shipping and population growth will keep up demand for crude, but the leading oil companies will have to curtail costs further to maintain current earnings.

 

On what has been said, it seems difficult to benefit from the transition in the car industry, but Glencore, BHP, Albemarle, FMC, Geely or VW seem to be reasonably positioned to profit from this development.

 

 

 

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