Fear And Fundamentals

The title is stolen from the latest note by most bullish strategist on the Street, but I will return to it after a jump. However, let's look at fascinating sentence, in my humble opinion, delivered by the guys at GaveKal today:

We remain buyers of equities on the medium-term, but we fear that the current macro headwinds will dominate the fundamentally sound micro environment, at least until we have more clarity in Europe.

Who ever thought that macro headwinds are caused by delusion of fundamentally sound micro environment? Is this the mind-trap of "cream lickers" at efficient frontiers, who forget that in the real life debt markets are at least 2 times bigger than equity markets? Well, let it be ... but it appears I am not alone in thinking on private sector stability.

Now, back to Binky Chadha and the team at Deutsche Bank. The latest message from yesterday in a short summary:

The tension between improving US economic and corporate fundamentals versus first sovereign credit then economic slowdown fears in Europe has buffeted equities recently. In our view:

(i) Fundamentals: the sales-production gap is only a third of the way through correcting and will continue to drive the US recovery; high cash flows and balances are supportive of corporate spend and equities; as is investor positioning;

(ii) Fear: direct earnings impacts of slower Euro area growth and euro depreciation are limited; more important contagion source is spillovers from interbank markets where spreads have widened but in the US only to their pre-crisis average level;

(iii) Too much fear in the price: the market is pricing in too high a probability (37%- 48%) of the worst-case scenario; we think it is much smaller (less than 10%);

(iv) Near trough multiple: the trough multiple of 13x NTM EPS (S&P 500 1100) has held in the last 3 corrections and should continue to hold in a baseline of US recovery;

(v) More up than downside: history suggests following an 8-10% correction the upside potential (9-15%) is significantly larger and higher probability than the downside;

(vi) Strategy: the turn in the labor market, growing regional divergence and dollar appreciation reinforce our calls to overweight the US, Discretionary and Financials, underweight Energy and Materials; and domestic over foreign exposure in stocks.

Click on chart to enlarge, courtesy of Deutsche Bank.


I have been looking at issues around the US consumer, but the production gap maybe is explained by the uncompetitiveness of US economy? Think of Twin Deficits?