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A gentle deceleration?

3 August 2018

The week has been good US tech giants, not great for Chinese and Hong Kong stocks, and choppy for UK and European companies.
Donald Trump upped the ante in the trade war with China; China responded in a measured way that could be read as political nous, but is likely to read as economic weakness by its rival.
The economy’s more forward-looking data continued to signal a gentle deceleration. Forward-looking components like PMIs slowed but aren’t yet signalling weak growth, and the July US employment data showed a slightly less bullish condition than June’s stonking report.
Meanwhile, the central banks of the US, UK, China and Japan were busy changing interest rates and sending signals.
Apple and Tesla hogged the limelight with Q2 results which were warmly received. Apple surprised in earnings per share (partly by reducing the number of shares…) but the main joy was in their guidance, increased beyond even the most optimistic analyst forecast. Margins were boosted by selling more of their higher priced items and, in particular, the previously not-so-popular iPhone X. At $207.05 per share, it became the first public company to reach the $1 trillion market capitalisation.
Apple is a different tech animal to Google (Alphabet), Amazon, and even Microsoft. With a P/E of 19x trailing earnings, it’s a lot “cheaper” than their respective P/Es of 31.6, 186.3 and 28.9. (as of Friday 2:15pm BST). All of them produce earnings however, and all look cheap compared to Tesla, which lost $635mn in Q2 on an adjusted basis. But for the first time, they made an operating (gross) profit of $618mn and it’s entirely possible that 2019 will be properly profitable. There has been an awful lot of speculation about Elon Musk’s company running out of cash, but this report showed a Q2 with positive operating cashflow. The shorts got squeezed and Tesla is likely to close out the week as the best performer of the most-talked about US “tech” stocks.
There is an alternative view about why US tech stocks are doing better, and that’s linked to the US-China trade war. We look at developments below. It’s interesting to note that, since mid-May, the performances of the region’s stock markets have looked like mirror images of each other.
The Chinese continue to be in a weak tactical position, even if the longer-term is much more in their favour. As such, the continued ratchetting up of pressure by the US is likely to continue, with the US looking for signs of a breaking point. While the US is not happy with a stronger dollar over any prolonged period, a near-term push up pressures the Chinese by encouraging capital outflow. That mirror-image may suggest this is what is happening. Even though an improvement in competitiveness should help Chinese businesses, the signs are that they’re being starved of capital.
The start of the month always brings the flood of forward-looking data known the Purchasing Manager Indices. JP Morgan does a great job in amalgamating them to produce a global version. Interestingly, despite raising rates, the Bank of England used a version of the chart below to emphasise their dovish tone.
Reporting on the global PMIs, JP Morgan said that “At the sector level, two of the three output PMIs declined in July.” They also added that weakness in EM Asia suggests activity won’t accelerate as they had previously predicted, while there were large declines in other EM regions.
All in all, we’ve been of the view for some time that activity has been slowing, with the US being the outlier. The overall trajectory continues, although we remain reasonably sure that Europe will gain as the US slows in H2.
Lastly, bond yields rose slightly across the week, driven by the moves from the Bank of Japan partly (see below) and, probably more importantly, by yet another surprise increase in bond issuance by the US government. We’re entering a very important phase for bonds during this half year. It is quite possible that central bank action (in running down their bond-buying operations) may stop the longer maturity yields from falling, even when economic data would suggest that outcome.