In this briefing:
- Free Money Has Flown
- Komatsu, HCM, CAT: The Stock Punishment Does Not Match the Outlook Deterioration Crime
1. Free Money Has Flown
The world will soon discover that debt matters.
The announcement of each round of QE increased asset prices, but the effect on Treasury bond prices began to fade when central bank purchases began. This unexpected behaviour revealed a little-known fact: asset prices react more to the expectation of changes in liquidity than to the experience of greater liquidity in financial markets. By contrast, economic growth is subject to the fluctuating standards of commercial bank lending, which follow variations in the demand for credit. Consequently, financial markets lead the economy. Meanwhile, central banks focus on lagging indicators, so they’re followers, not leaders. Bond markets usually predict more accurately than stock markets. To work, central bank easing policies require real risk-adjusted interest rates. However, with those rates below zero in many countries, further reductions would penalise lenders without helping borrowers. Thus, only rising inflation can save stressed debtors.
2. Komatsu, HCM, CAT: The Stock Punishment Does Not Match the Outlook Deterioration Crime
We have been struck by the degree of underperformance of the construction machinery names despite strong earnings performance. While the cyclical nature of the names makes judging performance purely on earnings results (or even the outlook) hazardous, in this case we believe the market has been premature and excessive in its derating of these stocks which have sold off to similar levels as the WFE names such as Tokyo Electron (8035 JP) and Robotics names such as Fanuc Corp (6954 JP).
While it is possible that Komatsu Ltd (6301 JP), Hitachi Construction Machinery (6305 JP) and Caterpillar Inc (CAT US) have sold off partly due to their China exposure, it needs to be emphasised that 1) these companies are no longer heavily dependent on China and revenue exposure is 12% for HCM, 10% for CAT and 7% for Komatsu, and 2) while the Chinese market at about 60k excavators is probably close to the top of its cycle, it is not a bubble like in 2010 when it 111k units and thus a collapse in demand is unlikely (though a decline is).
As the table below notes, earnings estimates for the construction machinery companies have only tapered marginally from their peaks, and while find the forecasts for continued growth into 2020 somewhat optimistic the resilience of mining demand means we are disinclined to dismiss them out of hand. On the other hand estimates for WFE and Robot names have dropped significantly, but despite this, share price performance is similar for all three categories of stocks. We discuss this stark discrepancy further below.
Change in 2019 OP Estimate Vs. Peak | Peak OP Estimate Date | Peak to Trough Share Price Change | Share Price Vs. Peak | Peak Share Price Date | |
Caterpillar | -6.4% | Aug 18 | -35.2% | -21.4% | Jan 18 |
Komatsu | -2.1% | Dec 18 | -49.7% | -38.8% | Jan 18 |
Hitachi Construction Machinery | -4.6% | Oct 18 | -50.5% | -41.2% | Feb 18 |
Average | -4.4% | -45.1% | -33.8% | ||
ASML | -10.1% | Jan 19 | -31.2% | -14.4% | Jul 18 |
Applied Materials | -38.4% | Apr 18 | -53.2% | -36.8% | Mar 18 |
LAM Research | -28.7% | Apr 18 | -46.4% | -21.3% | Mar 18 |
Tokyo Electron | -36.6% | Jul 18 | -49.9% | -32.4% | Nov 17 |
Average | -28.5% | -45.2% | -26.2% | ||
Fanuc | -44.7% | Mar 18 | -52.9% | -42.4% | Jan 18 |
Yaskawa | -34.7% | Mar 18 | -58.5% | -47.0% | Jan 18 |
Harmonic Drive Systems | -43.2% | May 18 | -65.9% | -49.3% | Jan 18 |
Average | -40.9% | -59.1% | -46.2% |
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