US Stock Market Is Beating the Rest Of The World... By A Wide Margin
The US-based market's performance in the S&P 500, Dow Jones and Russell 2000 have diverged from the rest of the world. The Trump Tariff narrative has devastated emerging and developed markets. The SPY is up roughly 9% on the year, while Taiwan is the only country in Asia positive on the year. China's markets are down nearly ~19% this year due to 25% tariffs on $60 billion worth of goods exported to the US and an increasing probability for an additional $200 billion 10% tariffs expected to be rolled out later in the month.
Index Weighting Has Pull
The top three holdings in the SPY are Amazon (AMZN), Apple (AAPL) and Microsoft (MSFT) and they have contributed to over 3.71% of the annual return in the ETF. The chart below shows how heavily weighted the top three stocks are and how much pull they have on the S&P 500 index. Amazon, Apple and Microsoft are up 70%, 35% and 33% YTD and they account for nearly 1/3 of the indices return this year.
These companies continue to surpass investors' expectations and report record revenues and profitability. Both Amazon and Apple surpassed the trillion-dollar market capitalization mark this year on the strength of the US consumer and economy.
What's A Better Buy? Top Tech And FANG Or The Rest Of The Bunch...
The performance of the top technology names has given investors outsized returns compared to the rest of the indices' holdings. Professional and retail investors alike have resorted to momentum and technical-based trades, as the average return of all the FANG stocks is ~41% YTD.
Most of the performance in FANG can be attributed to Netflix (NASDAQ:NFLX) and Amazon, which are up 90% and 68.5% this year. Amazon continues dominating the eCommerce space with 50% of the total US market share, while Netflix grew their subscriber base to 1.48 million domestic and 2.08 million international subscriptions through the first six months of 2018. The market continues to pay a premium for growth as the FANG stocks have earned a combined $392 billion in revenue over the last 12 months, which is on pace to match the total economic output of the entire country of Colombia (GDP is ~$400 billion).
Eurozone Investment Landscape Remains Stagnant
The largest economies in Europe are down in the mid-to-high single digits and there is no sign of recovery on the horizon. GDP across the Eurozone is stagnant in the middle 1% range and the European Central Bank "ECB" is going to stop the quantitative easing program that has pumped €30 billion euros a month across the member nations. One of Mario Draghi's final act as the head of the ECB will be to raise the central bank's lending rate into positive territory and usher in an era of rate normalization across the Eurozone.
Germany (EWG) remains the only investment worthwhile in Europe as German GDP is running strong towards 2%. Interest rates on Bunds remain in negative territory and the tertiary countries in Europe are dragging the Union's growth rate towards 1%.
Steer Clear of Italy And Spain
There is uncertainty about the Italian government and the potential for a new government formation amid a debt crisis that saw the Italian yield curve approach inversion. Countries such as Spain and Italy continue to face extreme economic difficulties with unemployment running towards 15.3% and 10.4% respectively. Unemployment is high across the EU and underemployment remains a problem. When I spoke to a business associate in Santander, Spain, he claims the vertical career opportunities in the EU are significantly lower due to the competitive nature of the job market and the high level of education required to obtain them.
It is common for employers to offer unpaid internships to college graduates, and require employees to have masters and doctorate degrees to obtain entry level jobs in professional services. The structural dynamic of the European job market is materially different than the US and this is reflective in the investment and growth projections across the EU. The EWI and EWP funds provide investors access to the Italian and Spanish markets and are trending extremely bearish. These funds should be avoided at all costs if you are seeking to invest in Europe.
How To Play Europe?
To provide diversified exposure to the entire Eurozone, I target Europe through FEZ and VGK. Each fund has characteristics that give them slightly different exposure to the European investment thesis. Both funds have lagged the S&P 500 by 13%-15% this year and the investment conditions are not favorable at the moment for European equities.
Looking At The FEZ
FEZ tracks the EURO STOXX 50 Index and has 70% exposure to French and German markets. The fund has 3.1 billion of assets under management and the liquidity on the stock is above average. The price to earnings multiple is 13.3 and this is about half of the S&P 500's multiple at 25 times. European assets are cheap and this is because of the lower growth prospects across the Eurozone. The fund pays a 3.28% dividend yield and the top two holdings are Total SA (TOT) and SAP SE (SAP) by accounting for 10% of the entire fund holdings.
The expense ratio is relatively high for an index ETF at 0.29% and you pay this premium for the right to deal in the liquid equity options. I use this ETF for the liquidity in the options market and low bid/ask spread for favorable options trade execution. This fund offers weekly expire options contracts and bid/ask spreads below 5 cents. The FEZ has underperformed the VGK fund by roughly ~2% YTD and both funds are negative on the year.
Analyzing The VGK
Vanguard's fund seeks to track the performance of the FTSE Developed Europe All Cap Index. As expected with a Vanguard fund, the expense ratio is best in class at only 10 basis points. The fund has about $16 billion under management and is extremely liquid when trading shares. The portfolio composition is slightly different than FEZ, as nearly 30% of the fund is exposed to the United Kingdom. The fund has significantly more diversification as the top ten holdings account for only 16.7% of the fund's portfolio.
The dividend yield is higher than FEZ at 3.45% and provides a better income component. I don't use this fund when I need to invest in options. Equity options are not as liquid and there are no weekly expire options offered on this ETF, only standardized monthly. The strike prices are in dollar increments and the bid/ask spread is greater than 10 cents for most options.
Latin America doesn't look much better with trouble brewing in Argentina and Venezuela. Venezuela is on the verge of total collapse amid the worst hyperinflation since World War 1 and post-war Germany. Venezuela's economy is heavily tied to the price of oil and the government derives a majority of their revenues from exporting crude the US Gulf Coast refiners. The Bolivar is experiencing hyperinflation and the Maduro regime is enacting extreme monetary policy by attempting to peg their currency to a cryptocurrency named "Petro," which is supposedly tied to crude oil.
The Venezuelan yield curve has inverted and 1-year treasuries are yielding 200% to maturity. The economy is on pace to contract nearly 17% for 2018 and the country is near collapse. The troubles in Venezuela can become a contagion for Latin American countries as an influx of refugees are creating an immigration crisis in neighboring countries such as Colombia. Anti-immigration policies are becoming more prevalent around the world as the humanitarian crisis spill over borders.
Argentina isn't faring much better as their central banking mechanism just raised interest rates to 60% in an effort to stem a collapse in the Argentinean Peso. The ARGT is down nearly 26% this year and the IMF is pledging full support for the reeling economy to counter the austerity policies of the government. Without mentioning the troubles in Brazil (EWZ is down 21% this year), Latin America remains the toughest investment in the world and investors should shy away from this continent.
China Remains Depressed
The biggest opportunity across the world for investors lies in the second biggest economy in the world, China. The GDP numbers are still running hot towards 7% and the devaluation of the Yuan is counteracting any export concerns as US purchases of Chinese goods get more product for the dollar.
The valuations in Asia are extremely depressed and appear worth a look as the price to earnings multiple is approaching Europe levels with price to earnings near 11-13 times, with growth prospects in the high-single digits. The sales growth rate for Alibaba (BABA) is 60% and Tencent (OTCPK:TCEHY) is ~30%, which shows the growth prospects are extremely high and worth owning.
The top two ETFs to target China directly are FXI and GXC, and these funds have $4.67 and $1.02 billion assets respectively. The funds are down 9.5% and 11.9% to date, and this is due to the slightly different exposure.
The top three holdings in GXC are Tencent, Alibaba and China Construction Bank (OTCPK:CICHY) accounting for nearly 30% of total holdings, whereas the top three holdings in FXI are Tencent, China Construction Bank and Commercial Bank of China (OTCPK:IDCBY) accounting for 26% of total holdings. The goal of FXI is to provide exposure to the 50 largest companies in China and GXC holds around 374 companies that provide exposure to the entire China market.
How To Play China?
My belief is the US will not enact tariffs on $200 billion in Chinese goods and the Asian markets will begin a slow recovery. The trade/investment in China is dependent on the Trump Tariffs easing and investors regaining confidence across the Asian markets. There is psychological damage to Asian investors because Trump has proven himself crazy enough to implement an across the board 10% tariff on $200 billion of goods from China. Trump won't back down until he wins concessions from the Chinese government.
The US economy will experience retaliatory tariffs on exported goods because the trade deficit ratio is 3 to 1 towards China. The thought process is since the trade deficit is so large, it will hurt them more than it will hurt us. With Chinese assets being depressed nearly 10% YTD, I think investors should build a position in China ETFs GXC and FXI heading into the September 23-25th tariff decision/rollout.
The China investment narrative is dependent on if the tariffs actually go into effect. The 10% tariff won't be instantaneous, it will take a period of months to implement. In the meantime, it looks possible the Chinese government will come to the negotiating table to appease the US trade demands. I find it highly probable heading into November elections the Republicans will want the markets heading upward and Trump will pull off some masterful negotiation that makes him appear an astute businessman who won the trade war.
Disclaimer: Copper Canyon LLC is a Registered Investment Advisor in Orlando, Florida. We have outlined our market commentary, and all information detailed in this article is not investment advice; it merely indicates the opinions and views of Copper Canyon LLC and its Investment Advisors. Any forward-looking statements or share price calculations should not be construed as Investment Advice and are for market commentary purposes only. Forward-looking statements are not indicative of future performance and cannot be interpreted as such. We have no responsibility to update any forward-looking statements. This commentary was created by Dylan Quintilone, Investment Advisor Representative of Copper Canyon LLC. Copper Canyon LLC is a State of Florida Registered Investment Advisor.
Disclosure: I am/we are long SPY, VGK, FEZ, GXC, BABA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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