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Technology, Tariffs, and Emerging Markets

By Louis Llanes | September 16, 2018

Today we’re going to touch on the tradeoff between technology and emerging markets. There’s a lot of talk about the tariff negotiations, and the elections that are coming, which could affect the negotiations if the Republicans lose control of Congress in the midterm elections.

By Louis B Llanes, CFA CMT
Founder, Wealthnet Investments, LLC 

Today we’re going to touch on the tradeoff between technology and emerging markets. There's a lot of talk about the tariff negotiations, and the elections that are coming, which could affect the negotiations if the Republicans lose control of Congress in the midterm elections. Trump has been able to implement tariffs unilaterally based on a rule that allows for this to be done if intelligence and national security is compromised. This whole concept, however, could be challenged if Democrats take control of Congress.

Tariffs are being opposed by different trade groups in the US that are hurt by these changes and these groups could continue to lobby harder to stop them. There is a theory that Trump will be even more aggressive in pursuing more tariffs, regardless of the outcome of the midterms - the reason for this is if the trade pacts in the EU and Mexico are formed, it could help the US in a multilateral assault against the Chinese anti free trade practices.

Those practices bring along problems such as stealing of intellectual property, government protection of Chinese companies, blocking foreign firms from free trade with high regulations and red tape, and currency manipulation. This is important and relevant because right now the Chinese stocks and emerging markets are down and underperforming the US.

If continued improvement happens on the tariff front, one contrarian view could be that the emerging market stocks could do well compared to the US because we'd have kind of a move back towards the norm and that viewpoint will make more sense after looking at the valuation of Chinese stocks.

 

Chinese Stocks Attractive Compared to U.S.

Let’s take a look at the Chinese ETF, symbol MCHI. The price to earnings multiples is a valuation metric and the lower, the better. Right now Chinese stocks are trading at 10.52 times earnings, compared to a basket of large US companies trading at 17.36 times earnings. MCHI is also outperforming the Large Blend US in the Dividend Yield category, with 2.55% compared to the 2.19% from the US.

Also important, the expectation for long-term growth in China is faster than that in the United States. If you look at the Wall Street long-term earnings per share, a five-year growth estimate, we’re at 16% growth in China versus 12% in the US. According to these metrics, China looks more attractive.

With that said, it's best to look for stabilization before you start picking these stocks up. The value players are probably nibbling at it now, but we would personally like to see some stabilization before we'd get aggressive with that.

We do have some Chinese stock positions that look attractive to us, particularly in the consumer and tech areas.

S&P – Positive Strength & Momentum

We’ve been asked a lot recently what we think of the stock market in general. Let’s look at factors with the ability to give you some probabilities; the first factor would be the valuation multiples. As mentioned earlier, the US stocks are trading at about seventeen times forward earnings. That's over a five percent earnings yield, and if you compare that to the 10-year treasury today, which is at 2.977, it's a reasonable valuation.

If interest rates stay relatively stable, and don't rise too fast, the valuation squeeze shouldn’t be too bad, so that's a bullish sign.

The other thing is we have momentum on our side. We're at the highs of the trading range now. Our momentum and breadth indicators are still showing positive strength technically, which indicates a positive market moving forward.

Tech Sector in an Uptrend

Now for a look at technology stocks. If we look at the relative performance of these stocks, they have been in an uptrend and now they're at the top end of the trend line. What that indicates is that these are a little bit overbought in a relative basis and we've seen that the relative performance has stalled at the end at that level a few times.

So is that a sell signal for tech? We believe that's just an early warning sign to be careful that these tariffs can have an impact on tech stocks, and that makes a lot of sense because many of the supply chains that our tech companies rely on come from China.

Medtronics – Medical Devices with Good Valuation

Now for two stocks that we're looking at. The first that looks very interesting is Medtronics - one of the largest medical device companies. They develop and manufacture therapeutic medical devices for chronic disease. We like this because the bullish case is that they have attractive treatments for atrial fibrillation and aortic stenosis. It's a good demographic and their leadership position is very strong relative to the sector along with looking good on a valuation basis as well.

Huntington Bancshares – Regional Bank with Room to Grow

Another stock that we like is one we’ve talked about on a previous Market Call - Huntington Bancshares.
They're a regional bank headquartered in Columbus, Ohio, and most of their exposure is related to the auto industry. They're in blue collar states, Ohio and Michigan and they have very high concentration in autos.
Given the fact that there is a positive backdrop for autos, we think this could be an exceptional grower and on a valuation basis they look attractive compared to other financials.

These are the types of companies that make sense to trim and trail, where you would trim back some of your winners in tech and move into some of the other names that look better on a valuation basis in our opinion.

Summary

In summary, tariffs are impacting various sectors in the market. It’s theorized that Trump will continue his aggressive stance in regard to tariffs regardless of the midterm outcomes.

Chinese stocks are set up for some long-term growth and look relatively strong compared to some large US companies at this time. That being said, it’s important to look for stabilization before taking an aggressive approach.

The general market should have a positive forward move, providing interest rates stay stable. We’ve got momentum on our side along with high earnings yields.

The tech sector has been in an uptrend but is leaning towards overbought. This isn’t a sell sign necessarily, but it does call for some caution due to the impact tariffs could have on this industry.

We like Medtronics and Huntington Bancshares – two strong and attractive stocks. One is a medical device company with good valuation, the other a regional bank with great growth potential in the financial industry.

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