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The financial markets have finally cottoned on to the increasingly sordid political realities created by the Trump White House. Trump could well be impeached for obstruction of justice if he tried to pressure FBI Director James Comey to drop an investigation on disgraced General Michael Flynn’s contacts with Russian intelligence before the election. The appointment of a special prosecutor to investigate the scandal means Washington is now mired in a constitutional scandal that will make it impossible for the Trump administration to enact its tax reform/deregulation agenda. This was the reason the Dow Jones index plunged 372 points, the ten year US Treasury yield sank to 2.20%, the NASDAQ fell 158 points and safe havens like the Swiss franc, Japanese yen and gold surged against the US dollar on Wednesday. The political scandal in Brazil and the meltdown in the Bovespa and the real has only amplified the angst in risk assets. Is the Wall Street sell off just an ephemeral market or something more ominous, a trend change, requiem for the bull market?
The US stock markets’ ‘irrational exuberance’ since the election was based on sound macroeconomic logic. First quarter earnings were a beauty. Jobless claims are at a 28 year low. Housing, gasoline prices and wage growth still anchor consumer spending. Silicon Valley’s tech revolution once again has mesmerized the world. Yet Mr Market more than priced in all the good news at 18 times earnings and stratospheric valuations in Dr Schiller’s CAPE index. The stock market discounts the future, not extrapolates the recent past – and the future has darkened since Robert Mueller’s investigation could well lead to the political demise and possible impeachment of Donald Trump. This is Watergate 1974 all over again, not exactly a benign backdrop for the US or world economy at a time of epic geopolitical tensions in North Korea, Syria and Iran. Treasury Secretary Steve Mnuchin’s testimony to the Senate Banking Committee, while suave and optimistic as befits an ex Goldman Sachs partner, has not exactly reassured Wall Street. Thursday’s price action is a classic dead cat (actually kitten!) bounce though the Dow rose 140 points on Friday. Trump’s decision to renegotiate NAFTA creates yet more uncertainty in international relations and trade policy – and his decision to go to Israel, Saudi Arabia, the Vatican and Brussels on a state visit will not end the turmoil in Washington.
Financials were the quintessential Trumpflation sector since faster economic growth, a repeal of Dodd Frank, tax cuts and a steeper US Treasury bond yield curve fatten bank profits. So it was no coincidence that Bank of America and Goldman Sachs, the poster boys for the post-election money centre bank rally, both lost 5% in a single session on Wednesday. I believe financial stocks must not roll over or the bull market is toast. The fall in the US Dollar Index below 98 and the ten year US Treasury note at 2.20% tells me that the capital markets have scaled down their expectation of aggressive Federal Reserve monetary tightening this autumn. Will Janet Yellen raise the Fed Funds rate at the June FOMC? Yes, the logic of the Fed’s dual mandate has flashed green. Will a political crisis in Washington shape the time of the Fed’s balance sheet normalisation? Yes. This is the reason I am no longer willing to accept the risk reward calculus in most money centre bank shares and now await Citigroup’s fall to 56 or Goldman Sachs below 200.
Technology’s megacap darlings (FANG) and the Philly semiconductor index have also been fabulous money makers in 2016 and 2017. In fact, it is impossible to trade the S&P 500 index or NASDAQ without a continual real time grasp of the bull-bear debate in Facebook, Apple, Netflix, Google and Amazon. These are the megacap colossi who dominate the world’s biggest stock market indices. If the bull market dies, expect carnage in these Big Five shares as the sheer tsunami of leverage index selling hits Wall Street. Donald Trump’s fate is now in the hands of the 535 men and women in Capitol Hill who run American politics. The fate of the bull market on Wall Street also could be in the hands of the Congress – and the special prosecutor who will investigate whether Donald Trump colluded with the Russians, and then lied to the American people about it. The ghost of Richard Milhous Nixon now haunts Wall Street.
Macro Ideas: Pakistan’s financial fairytale continues!
Necklaced by the Margalla Hills, with its white marble mosques, heavily guarded diplomatic enclave, its geometric grid and lavish mansions, Pakistan’s capital is an unlikely host to one of the most exciting growth stocks I have ever encountered in the frontier markets. I have made no secret of my conviction, expressed ad infinitum in my column since 2012, that Pakistan (and Argentina) are a frontier market fairytale. Pakistani shares are up more than 400% for US dollar investors since 2012, making the Karachi stock exchange one of the world’s best performing stock exchanges. Of course, it was not money making ideas but my love for my darling father, my lifelong friend and mentor that took me to Islamabad.
I got an invaluable feel for the real time political and economic realities of Pakistan. In the past three months, I have been fortunate to talk to some of Pakistan’s top industrialists, diplomats, money managers, bankers and even a historian whose own father was Zulfiqar Ali Bhutto’s Intelligence Bureau chief. The spectacular bull market on the Karachi exchange (now 40% owned by Shanghai Shenzhen) reflates these new macro realities. Karachi was Asia’s best performing stock exchange last year, up 46% in 2016. Yet Pakistan still trades at only 10.8 times earnings, offers a 7.6% dividend yield and earnings growth of 15%. True, the Pakistani rupee is a tad overvalued and can well depreciate to 12 against the US dollar. Yet Morgan Stanley has upgraded to Pakistan to emerging market and the index will attract at least another $300 million in tracker funds. Conversations with friends tell me hundreds of new foreign fund managers have opened institutional new accounts in Pakistan. The megacity by the Arabian Sea, the city of my birth, is also the epicentre of the most frenzied property booms in Asia outside Hong Kong.
I have an emotional reason to be attracted to Shifa Hospital in Islamabad. After all, the world class cardiologists there saved my wonderful daddy’s life. However, Shifa is easily the most attractive health care proxy in this nation of 190 million people with a quantum increase in affluence, third party medical insurance, the planet’s highest fertility rates and a chronic shortage of hospital beds. I remember Shifa shares trading at 5 rupees in 2003, just after the trauma of 9/11 and the US invasion of Taliban ruled Afghanistan, at the start of Pakistan’s darkest decade in its history.
Shifa Hospital now trades at 265 rupees or 3 times book value. Shifa trades at 16 times forward earnings. The market cap is $140 million dollars. The hospital operator has a scalable model that can easily deliver 20% earnings growth (CAGR) in the next five years. With its major specialties, its diagnostics labs, I can well understand why a Dubai private equity colossus tried (and failed) to buy a controlling stake. I believe Shifa Hospital can rise to 400 rupees by end 2018.
My father was trained in the aristocratic Lloyds of London firm Willis Faber Dumas (the syndicate that insured the HMS Titanic!) in Britain and has used his contacts in the London reinsurance market to help government ministers on complex multi-billion dollar projects. Reinsurance is mission critical to the success of the $46 billion China Pakistan Economic Corridor, which will also transform the energy sector and add at least 2% to the structural growth rate. Thanks to Xi Jinping, Pakistan is South Asia’s new tiger economy, a vast hub that will link Sinkiang and Central Asia to the Arabia Sea.