Current racing conditions: firm for now. Q4 preferences: neutral equities, within equities overweight euro zone and Japan. Overweight cash at the expense of bonds. Neutral duration bias in core bond markets.
This week: Enjoy the rally while it lasts- it isn’t trustworthy, Japanese equities: positive structural themes versus weak domestic economic data, ‘price gouging’ and US pharma
Enjoy the rally while it lasts- it isn’t trust worthy
- The last fortnight has seen a marked turnaround in investment conditions. Bargain hunting by investors after a miserable August and September has been supported (ironically) by weak US economic data.
- Weak jobs growth in the US has probably killed off the chance of a Fed rate hike this year. This, in turn, has contributed to a weaker dollar which has given a boost to US exporters (48% of S+P 500 earnings are from exports), commodities and emerging market stocks. Meanwhile, commodity prices have been boosted by long overdue output cut announcements, with Glencore’s recent financial problems highlighting need for still more cuts across the mining sector.
- The MSCI World Index of developed stock markets is up 5.8% in USD terms (4.7% in GBP) since the beginning of October. The index is, however, still down slightly at 0.55% in USD (while up 1.3% in GBP).
- This risk-on rally is not trustworthy and I would hesitate to increase long-term risk exposure on the back of it. The original reason for the Fed not raising rates in September – a weakening Chinese economy that threatens to export price deflation- remains in place. Meanwhile, the precariousness outlook for US corporate earnings growth is perhaps highlighted by stock market investors revealing themselves more worried over a feared 25bp rate hike than weak US labour data, at a time when the labour participation rate remains at a 38 year low.
Japanese equities: positive structural themes versus weak domestic economic data
- After significantly underperforming other major stock markets in recent month, in both USD and YEN terms, Japan has outperformed so far this month with MSCI Japan up 7.3% in USD (7.8% in YEN). I remain positive on the county’s stock market.
- A number of factors are involved, including further quantitative easing that is expected from the Bank of Japan as long as the economic data remains weak, and the recent pick-up in momentum amongst the U.S and Pacific governments to sign the Trans Pacific Partnership (TPP) trade agreement. The TPP is widely expected to help Japanese corporates boost exports in the region. Furthermore, corporate reform legislation in Japan is leading to greater transparency and better governance.
- However, the current domestic economic headwinds will continue to cause disquiet. Third quarter GDP is likely to have contracted for the second quarter in a row, which is the formal definition of a recession. A VAT increase earlier this year, together with a niggardly summer bonus season as companies hold onto their cash, has dampened consumer spending growth. Export growth to Japan’s Asian neighbours, particularly China, is sluggish and has been a contributing factor in industrial output data currently being flat over a year ago. Core inflation has fallen back to negative territory, despite massive previous doses of quantitative easing delivered by the Bank of Japan.
‘Price gouging’ and US pharma
- Hilary Clinton has highlighted the need for supply side reform of the US pharma sector. Punishing companies for ‘price gouging’ misses the point. The goal should be the global free trade of pharmaceuticals, with health and safety licencing along EU standards.
- The moral outrage of Hillary Clinton regarding drugs companies’ ‘price gouging’ and her promise to legislate against high prices in the sector, sounds a little false. To want to regulate and fine a company that is the sole distributor of a drug that commands monopoly prices, but not to address the reason why a drug has only one distributor, sounds too much like playing to the popular gallery.
- I refer to the 62 year old drug Daraprim, that is not covered by any patents. This is the Glaxo-made drug that sparked her outrage last month, when its sole US distributor Turing Pharmaceuticals announced a rise in the price from $13.50 a dose to $750 in late September. This is despite the same drug being sold in the UK for 65 cents a dose, and in India for around 5 cents (source: Wikipedia).
- Rather than regulating against ‘price gouging’, Hillary Clinton should be putting in place measures to attract competitive generic drug production in the US to compete with Daraprim. What are the supply-side constraints that stop new entrants from competing in a market where profit margins on the drug are currently so high? Is it the US Food and Drugs Administration (FDA) registration, or cartels in the pharmaceutical distribution sector? I know next to nothing about the US pharma sector, but Daraprim highlights obvious structural problems in supply that need addressing. Fines for companies that exploit these problems miss the point.
- The ultimate goal should surely be a global free market in pharmaceuticals, whereby American citizens can buy Indian-made drugs at near-Indian prices. With quality guaranteed by the global use of current European Union health and safety standards, whose higher hurdles trump the less discriminating FDA (witness the FDA’s recent acceptance of the Flibanserin, so-called ‘women’s Viagra’, after intense political lobbying and despite disquiet over side effects that had led to the FDA rejecting it twice before).