Dr Janet Yellen surprised the financial markets with her hawkish take on interest rate policy and inflation even as the FOMC raised the Fed Funds rate for the fourth time since December 2015. Despite successive weak CPI and auto/retail sales data, Dr Yellen asserted that the fall in inflation was transitory (data packages, medicine), that the US labour market was tight and that economic growth will be resilient despite doubts about Trump’s fiscal stimulus. The Federal Reserve also maintained its dotplot forecast of another interest rate hike in 2017, possibly as early as the September FOMC conclave. Incredibly, Dr Yellen even bought forward the timing of her plan to shrink the Fed’s $4.5 trillion balance sheet.
This ‘hawkish tilt’ was the reason the US Dollar Index soared from 96.25 to 97.50 after the FOMC statement while gold and growth stocks (NASDAQ) slumped. The divergence between the Fed’s forecast of three rate hikes in 2018 and implied forward rates in Chicago’s Eurodollar futures contracts has also widened, a metric of Wall Street’s skepticism on the new central bank ‘hawkish’ take on monetary policy. Hence the flattening of the US Treasury yield curve after the FOMC statement and Dr Yellen’s press conference in Washington. This is a recession risk SOS that investors will be wise not to ignore even as inflation break even rates in Uncle Sam debt plummet.
A $50 billion shrinkage in the Federal Reserve balance sheet is tantamount to a de facto 50 basis point hike in the Fed Funds rate. This means the planned balance sheet ‘taper’ (awful memories of June 2013!) could well trigger an inverted yield curve, a policy mistake and a US recession whose shock waves would devastate global financial markets. It is no coincidence that the flagship emerging markets index fund (symbol EEM) was slammed after the June FOMC. It is only a matter of time before recession risk hits psychology in US equities, now trading at 18 times forward earnings after 7% revenue growth and 14% earnings growth in 1Q 2017. Complacency in the debt market also means the risk of another bond market meltdown as the Fed continues to tighten this autumn.
Assume the Fed shrinks its balance sheet by $50 billion and raises the Fed Funds rate at least four times by next summer. This could well mean three month US Treasury bill trades at 2.75% or 50 basis points over the ten year US Treasury bond yield. This means an inverted yield curve would once again haunt the bond market. I can never forget that an inverted yield curve in 2000 and 2007 preceded draconian bear markets and economic recession.
Castigated by the financial markets for being too ‘dovish’ in the past, Dr Janet Yellen is now convinced that the resilience of the US economic expansion allows her to ‘normalise’ monetary policy before her term as Fed Chair expires in February 2018, even if the bond markets do not believe her.
The foreign exchange market is far more convinced about Dr Yellen’s intention to tighten monetary policy, the reason the US Dollar Index surged a full point above its November 2016 lows despite news that special counsel Robert Mueller has opened an investigation of the President for obstruction of justice (a Trumpian witch hunt!). The euro has plunged to 1.1140 as I write, not surprising given the latest Italian banking horror story and the fact that speculative longs in the euro were at six year highs. The euro was the mother of all crowded trades on the eve of the June FOMC. The unwind of the long euro rally since mid-April has now begun. This is a trend reversal.
It was no surprise that Governor Kuroda at the Bank of Japan kept his policy rate unchanged at minus 0.10% and reiterated his zero yield pledge on 10 year Japanese government bonds. Even though the Japanese labour market is now at its tightest since 1990, the peak of the epic Tokyo bubble, the idea of a premature ‘taper’ is anathema to the Bank of Japan and PM Shinzo Abe. The central bank decisions in Washington and Tokyo mean it is rational to expect dollar/yen to trade at 112-113 within the next two weeks.
Even though a ‘soft Brexit’ scenario led to sterling’s rise to 1.2760, the Bank of England is more worried about political uncertainty and Brexit than inflation risk. The slump in UK retail sales was inevitable as consumers were squeezed by higher petrol and food prices and a fall in real wages. This means the path of least resistance for cable is still 1.25 as the political fallout of the Grenfell Tower fire tragedy engulfs the Tories.
Stock Pick: Fox News is a media money machine for its parent!
Global media shares fulfil the gist of the ancient Chinese curse ‘may you live in interesting times’. The print business has been devastated by the online advertising revolution engineered by Google and Facebook. Subscription based video on demand content aggregators (and now content generators) like Netflix have revolutionised network television. ‘Cord cutting’ has hit the profitability of even the world’s most powerful cable empires, from Disney’s ESPN to Viacom’s Nickelodeon. The ATT-Time Warner merger and Fox’s bid for Britain’s Sky creates new models of scale economics and vertical integration. Regulators in the US have cracked down on advertising industry media rebates. On Wall Street, the rumour grapevine is surreal, from a Disney Netflix deal to the House of Redstone’s palace coups and family/boardroom battles at Viacom and CBS. This is a hugely complex, technology-backboned, global, constantly evolving business that utterly fascinates me and sometimes even generates compelling money making ideas. Like now with Fox.
21st Century Fox (symbol FOXA), run by James Murdoch (Citizen Rupert’s younger son) has been a mediocre investment in the past twelve months, down 2%. The news flow from Fox News, America’s most viewed news channel, has been absolutely awful. Both Roger Ailes, the founder of the network, and Bill O’Reilly, whose show generated ad revenues of $160 million per year (peanuts given Fox’s revenues in 2016 were $28 billion), were axed by the Murdochs after harassment claims by multiple women. Yet the meteoric political rise of President Trump, Fox News’s most favourite fan and a frequent guest on its shows, taps into the political zeitgeist of the new populist, extreme-right Republican Party partisans in America. Fox trades at a modest 14 times 2017 earnings and 12.8 times forward 2018 estimates at $28 a share.
The latest bad news to hit the shares is the hung parliament in Westminster, since several Labour MPs have voiced opposition to its $14 billion bid to takeover UK’s Sky, which would add 26 million households and an invaluable distribution platform in Europe to its global platform. Fox also owns Star India ($1 billion sales) made it an underperforming asset after Modi’s rupee demonetisation hit Indian ad spending and its failure to win broadcast rights to trophy cricket tournaments. However, Fox, shunned by Wall Street, is a classic case of Nathan Mayer Rothschild’s advice to buy shares ‘when there is blood on the street’ and Spike Lee’s dictum ‘don’t believe the hype!’.
My investment case for Fox rests on three assumptions. One, despite the setback to the Conservative party’s parliamentary majority in Westminster, Britain’s Ofcom will approve the deal in late 2017, albeit after protracted negotiations. This was the reason Sky (my virtual 24-hour companion in the endgame to the UK election) plunged 4% in London the day after the election even as the Footsie index rose.
Two, Wall Street underestimates the sheer earnings power, growth prospects and global appeal of Fox’s unique media properties – Fox News, National Geographic, STAR India, Fox Sports, FX, even Hulu. Take Fox News, which could well generate $1.8 billion in profits in 2017 or 26% of its parent’s profits and boasts an incredible 90.6 million subscribers, $6.7 billion in affiliate revenues and 65% cash flow margins. As America goes blood-red in partisan politics, Fox News is the mother of all media money machines.