In Mel Brooks’ seminal 1977 Hitchcock parody “High Anxiety”, much of the action revolves around the Psycho-Neurotic Institute for the Very, Very Nervous. Investors may feel the need to book into a similar establishment in 2019. Too many huge decisions need to be called correctly to feel relaxed about the year ahead.

Ninety years after the Wall Street Crash, global geopolitics and markets are like the person scaling a building on our front cover — in an exposed and precarious position.

And it’s a long way down. That’s why Reuters Breakingviews’ Predictions 2019 book is also titled “High Anxiety”.

Most investors already understand that Federal Reserve Chairman Jerome Powell and his fellow central bankers could get it wrong on rates, and exacerbate an outlook in which major economies are likely to expand more slowly. What may be less obvious is which companies will roll with the punches, and which will finish 2019 laid out on the canvas.

Private equity, where deals are being done at high prices with lots of debt, is the perfect starting point. Our view is that the real fall guys from lower returns won’t be storied buyout barons like Blackstone, but those who have advanced them credit on generous terms. An exception is Masayoshi Son, whose $97 billion Vision Fund will have some difficult conversations with its investors as it writes down a spate of overpriced purchases.

This could be happening at the same time as geopolitical strains draw parallels with another classic film, “High Noon”. A December détente between U.S. President Donald Trump and his Chinese counterpart Xi Jinping is a step forward, but relations between the two largest economies remain tense, and could worsen. In the corporate corral, guns will be drawn between activist investors and the French establishment, where we predict Vivendi and others are vulnerable.

Britain’s attempts to leave the European Union could yet avoid disaster, but a GDP-sapping no-deal in March is still a major risk. Italy will continue to rile the European Union, which could branch off in a more eurosceptic direction with European Parliament elections in May. Italian banks will bear the brunt of any return of “Quitaly” risk.

And the potential for the U.S. Congress to do what Trump won’t — sanction Saudi Crown Prince Mohammed bin Salman for the murder of journalist Jamal Khashoggi in October by Saudi agents — could destabilize the Middle East. But Trump now has the leverage to push MbS to undo many of his blunders — and keep oil prices low — and would be foolish not to use it.

For some, 2019 will be a year of recovery, and even success. Long-suffering Deutsche Bank has the scope to surf a wave of higher fixed-income trading revenue if rates keep rising. Italy’s woes could give Moncler boss Remo Ruffini a chance to remake his firm into an Italian version of Bernard Arnault’s LVMH. Rio Tinto will finally turn big miners into big spenders, Facebook could turn out to be the JPMorgan of tech, and Airbnb will succeed where others failed in China.

Meanwhile, businesses will continue to wrestle with the need to embraceenvironmental, social and governance issues — one area to watch is how actively banks use their bully pulpits to lobby gun manufacturers. With its traditional U.S. relationship in flux, look out for Saudi oil to be priced in yuan, boosting Beijing’s attempts to create a non-dollar hegemony. And a quarter-century after genocide, Rwanda will show the world that a single market with Ethiopia is better for growth than trade barriers.

What gives us the confidence to make these calls in an era when experts are shouted down? One reason is that they often turn out to be correct — witness last year’s forecast on bitcoin’s big wipeout. The cryptocurrency dropped from over $18,000 to under $4,000 during 2018. True, only half a side of SLAW was delivered with the IPO of Spotify and filing by Lyft to go public — but we’ll watch for Airbnb and WeWork to complete the acronym in 2019. And we said Amazon would bid for EU soccer, but didn’t expect football rights to fall in value.

Our overriding motivation is to provide thought-provoking, research-basedpredictions that don’t follow the herd. In 2019, investors can only hope that Powell and his central bank peers are similarly independent-minded.

George Hay

Associate Editor, Reuters Breakingviews

January 2019


High Level

Global equities offer value trap in 2019

China-U.S. trade war will get a lot more personal  

Private equity returns will drop a digit

Three key indicators to watch like a hawk in 2019  

Tech to disrupt supply chains more than trade wars

Japan is stealth threat to 2019 market stability

High Noon  

SoftBank writedown will cloud Son’s way forward

Activism anxiety will grip French establishment

Facebook might be the JPMorgan of the tech world

Italian banks to bear populism’s burden next year

Trump can get what he wants from Saudi in 2019  

Memo to Theresa May: How to save Brexit as well

High and Dry  

Goldman Sachs will spend 2019 in velvet handcuffs   

Buyout lenders will enter a new world of pain  

A made-in-America market will be a distorted one

General Electric can go from bad to worse in 2019

Brazil will get energy mostly right; Mexico won’t

Lyft, Uber IPOs will drain Tesla’s scarcity value

Financing drought cracks farmers’ loyalty to Trump  

High Flyers  

ByteDance will take over B in China’s BAT  

Airbnb will succeed where U.S. peers failed: China  

Deutsche Bank will be unlikely 2019 trading star  

Italy’s woes could spell LVMH moment for Moncler

East Africa will buck global great rift trend

Rio will turn big miners back into big spenders  

Starbucks will start brewing a venti Chinese deal

High Stakes

Chinese startups will get thrown an M&A lifeline  

Saudi oil will grease China’s currency ambitions

Jeff Bezos starts to resemble Sam Walton

Keep an eye on Seoul for Asia’s next big buyer

Firearms will test the mettle of woke financiers  

Indian unicorns will feast on richer pastures  

Glasenberg successor will run a different Glencore  

Next ECB boss will matter less than his sidekick

High Jinks  

The 2019 stock market reversal: how it happened

A Trump versus Xi wrestling match might just help 

Why I’m relocating to Paris in the year ahead  

A century on, bet on a new Black Sox-like scandal

Cannabis will take China tech’s path to propriety  

World will improve where it matters most in 2019

Global equities offer value trap in 2019


Are global equities cheap yet? After two sharp corrections in February and October 2018, investors will be running their rules over stock-market valuations. They should be wary of falling victim to a value trap.

On one measure, U.S. equities still look eye-wateringly overpriced. Economist Robert Shiller’s cyclically adjusted price-to-earnings ratio, or CAPE, which smooths the S&P 500 Index PE ratio over the prior 10 years, is running above 30 times based on data for November 2018. That’s in line with where it stood 90 years ago as the Wall Street Crash commenced, and second only to the 40-odd multiple seen in 1999 to 2000 during the dot-com era.

That’s not the whole story, though. After declines in 2018, U.S. equities in the Russell 1000 trade at 15.4 times next year’s estimated earnings, roughly in line with their 10-year average, according to FTSE Russell as of early December. And the CAPE picture looks more reasonable applying the upward-sloping trend line since World War Two. Assuming reversion to that trend, S&P 500 earnings per share would only need to increase 10 percent in 2019 for the market to grow into its current valuation, FTSE Russell reckons.

That’s less than half the 24 percent profit growth U.S. companies are on track for in 2018, albeit with a boost from tax cuts, according to Refinitiv data. As of early December, analysts are forecasting S&P 500 earnings expansion of 8.4 percent in 2019. The danger, though, is that at this stage of the cycle they are routinely too optimistic. Revenue, which turns into earnings, usually lags nominal GDP — where growth could slow in 2019. Leading indicators like the U.S. ISM Manufacturing Index may be peaking, too.

What about everywhere else? Forward earnings multiples in Europe and emerging markets are also in line with 10-year averages, and their discounts to U.S. stock prices remain in place. Emerging markets are relatively more heavily exposed to banks and big technology groups, and they tend to suffer an outsized response when the U.S. lurches down — a risk given the hoariness of the U.S. economic recovery, uncertainty over interest rates and trade tensions.

In fact, only in the UK and Japan do stocks look relatively cheap on an expected earnings multiple basis, but they come with extra layers of cloud covering the outlook. In 2019 there could be plenty of falling knives, and a dearth of safe bets.

First published Dec. 11, 2018.

China-U.S. trade war will get a lot more personal


American executives who prayed for a trade war truce are a disappointed lot. Following the arrest of Huawei’s chief financial officer in Canada, they’ve been sent to the front lines.

President Donald Trump is focused on the trade deficit. But administration hawks also want to thwart Beijing’s “Made in China 2025” plan to build state-subsidised global champions in sectors like aviation, artificial intelligence, and communications. The 90-day tariff freeze Trump negotiated with Xi Jinping has only halted hostilities in one corner of a vast battlefield.

Meng Wanzhou could be the first big casualty of American extraterritorial force. The United States alleges the Huawei executive violated its sanctions on Iran. Whether she did or not, arresting the daughter of the telecommunications equipment maker’s iconic founder Ren Zhengfei fires a loud shot across China Inc’s bow. Ditto for the October extradition of a Chinese intelligence agent from Belgium to face U.S. industrial espionage charges.

China could retaliate. It has already detained Canadian ex-diplomat Michael Kovrig, according to Reuters; his employer, International Crisis Group, says it is seeking his release. Huawei’s American rival Cisco Systems told employees not to travel to the Middle Kingdom after Meng’s arrest, although it later backtracked. Reuters reported the U.S. State Department is considering warning citizens not to visit the People’s Republic.

That might be prudent. Because it can be difficult to succeed in China without cutting corners, U.S. executives who have done so — or looked the other way while local employees did — are vulnerable, and can be held responsible for their company’s sins. Economic forces might also generate inadvertent flare-ups. Detention is a semi-legal negotiation tactic in the People’s Republic, usually the result of business disagreements over cancelled orders or price changes. In the past, upset Chinese managers have held foreign representatives involuntarily inside offices or hotels until they concede. Police rarely intervene. Foreigners can also be banned from leaving China until a dispute is settled. Reports of such incidents rose sharply during the global financial crisis.

As rising costs, tariff threats and general anxiety cause U.S. companies like GoPro to move parts of their supply chains out of China, more detainments could ensue. Even legitimate arrests will feed conspiracy theories. The popular emotions such incidents unleash could easily undermine efforts for lasting peace.

First published Dec. 12, 2018.

Private equity returns will drop a digit


Disappointment is coming for the clients of private equity firms. Companies which use debt and management wiles to take businesses private typically target an annual yield — the so-called internal rate of return — of at least 15 percent. It’s hard to see recent deals matching that. Instead of 15, investors should steel themselves for more like five.

For one, purchase prices are looking expensive. Deals struck in 2018 were at a median valuation of 13 times EBITDA, according to Refinitiv, compared with an average of 10 between 2010 and 2016. They’re getting bigger too. Blackstone’s purchase of a majority stake in the financial data business of Thomson Reuters — the parent company of Breakingviews — was the largest leveraged buyout since the financial crisis, worth $20 billion.

With generous debt, reasonable growth and a buoyant market in which to exit investments, that should be just fine. In a sign of what might be confidence, many buyout firms even include future cost-cuts in their measure of current profit when borrowing money from the debt market. The trouble is, it’s not likely the benign conditions will all hold for much longer.

Imagine a company taken private at 13 times its EBITDA of $1 billion, juiced up with $6.5 billion of debt, and held for five years. If its EBITDA grows at 6 percent a year, it will amass a total of $6 billion. Say a fifth of that goes to capital expenditure, in line with industrial norms according to CSIMarket, and just over one-third is eaten up by interest payments, leaving $2 billion after tax to pay down debt. If the private equity firm can sell the company at the same 13 times EBITDA, the fund would make a return of 15 percent a year, according to a Breakingviews calculator. That just about cuts the mustard.

What if things aren’t so buoyant? If valuations fall back to their historical average of 10 times EBITDA during that five years, and the growth in the company’s profit falls just slightly to 5 percent a year — which is hardly conservative — the annualized yield drops sharply, to 5 percent. Moreover, investors would still have to pay fees, cutting their returns further. An extra sting in an already unhappy tale.

First published Dec. 19, 2018.

Three key indicators to watch like a hawk in 2019


Want to know whether there’s going to be a U.S. recession, a flare-up in the trade war, or a spate of corporate implosions? You could stay glued to the news and social media. Or, if you have better things to do, just stay focused on these three proxy indicators.

First, take soybeans. American farmers have been early victims of the escalating response to President Donald Trump’s import levies. When crops from other countries like Brazil are relatively more valuable, it suggests traders are more worried tariff barriers will persist.

Then there’s the U.S. yield curve. Different experts pick different comparisons, but in the past when the yield on 10-year Treasury bonds has dipped below the return on two-year government paper, a recession has followed. As 2018 draws to a close, the gap is once again very thin.

Third, corporate health. One hint at sentiment comes from indexes that track how many stocks in given markets are in bear territory, meaning they have fallen 20 percent or more in value from their peak prices in the last 12 months. About half are in that zone in developed markets and more in emerging economies. That might mean shares are cheap. Or it might signify negative sentiment and an accelerating slide in 2019.

Tech to disrupt supply chains more than trade wars


U.S. President Donald Trump has a knack for claiming credit for others’ achievements. In 2019, his use of trade tariffs to boost domestic manufacturing will look like it’s working. But technologies such as factory automation are going to be the real reason global companies will manufacture more products locally.

Trump’s tariffs on China and other trade partners like Europe are a headache for companies that ship goods between the world’s three major economic blocs. Manufacturers like carmakers and pharmaceutical groups built low-cost, cross-border supply chains in the 1990s and 2000s, during which time worldwide trade doubled as a share of global economic output. BMW and Daimler import more than half the vehicles they sell in America, but also export more than half the vehicles produced at their U.S. plants, according to Moody’s.

That’s changing. BMW, for example, is mulling making more SUVs in China rather than incurring levies by shipping them halfway across the world from its South Carolina plant. And medical supplier Philips said in October it was “rearranging” its supply chain to make more American and Chinese products locally to avoid higher U.S. and Chinese tariffs.

But trade wars are only the latest force braking global trade growth. Having peaked at almost one-third of world GDP in 2008, trade flows shrank to just over one-quarter of output in 2016, according to McKinsey. And while the volume of global trade in goods grew at more than twice the pace of real GDP between 1990 and 2010, both grew at roughly the same average rate between 2012 and 2017, World Trade Organization data shows.

The aftermath of the global financial crisis bears a chunk of the responsibility. But a more structural change is that the benefit of making goods in distant countries with low wages is falling as machines replace people. High-tech plants run by software are easier to re-tool to make different products according to demand or geopolitics. Meanwhile consumer goods companies like Inditex , the owner of “fast-fashion” brand Zara, can quickly boost supplies of popular designs by producing them close to customers. That trend should spread beyond retail as 3-D printing techniques allow manufacturers to build complex, customised products more quickly.

Companies will produce goods closer to customers in 2019. Given the trend has as much to do with the switch from humans to machines as trade wars, the workers that Trump claims to be helping may not reap as many benefits as he touts.

Japan is stealth threat to 2019 market stability


What’s the biggest threat to global markets in the coming year? It’s not a rise in U.S. interest rates, or the end of the European Central Bank’s bond buying. Rather, it’s the Bank of Japan. Even small adjustments by Governor Haruhiko Kuroda to ultra-loose monetary policy could agitate global asset prices more than other, widely expected changes.

The BOJ already owns assets collectively worth more than the country’s entire GDP. Even so, it will keep growing its balance sheet after other major central banks have stopped. Any hints of a shift could alarm investors, whose assessments of risk and reward have been distorted by years of global central bank liquidity injections.

Reports in 2018 that the BOJ was debating scaling back stimulus triggered bond and currency volatility.

Kuroda is, in one sense, damned either way. Japan’s central bank is some distance from hitting its 2 percent inflation target. BOJ monetary policy is, however, aggravating the problems of regional banks. Roughly half of them have reported losses in the past two years or more on their lending business as the gap between what they pay for funding and what they get from making loans to customers has been squeezed.

If monetary policy risks doing more harm than good, the BOJ may be tempted to signal it’s willing to allow 10-year government bond yields to move in a wider range around zero or even raise short-term interest rates from minus 0.1 percent. Yields on Japanese government bonds would immediately jump. Nearly half are owned by the central bank and trading can be illiquid. Other markets will also feel the chill. Japanese investors have gone abroad to earn better returns, and will return if domestic yields rise enough. For example, Japanese investors bought about 4.7 trillion yen ($42 billion) of foreign currency bonds in September alone.

French and Spanish government debt, as well as U.S. credit, have proved popular relative to the size of the markets and could therefore face outsize hits. Currency hedging costs have risen so Japanese investors may bail out of overseas assets instead of paying for expensive protection. Those who have left their exposure unhedged to avoid paying for such insurance will be even quicker to do so.

Doubtless, U.S. Federal Reserve chief Jerome Powell, who is likely to keep raising rates throughout 2019, carries a big stick. But his actions are widely trailed already. That’s why Kuroda has the greater potential to jangle the market’s nerves.

First published Dec. 24, 2018.

SoftBank writedown will cloud Son’s way forward


SoftBank’s Vision Fund is due a writedown. The Saudi Arabian-backed tech investor, with $97 billion at its disposal, reported a 27 percent gain on $28 billion of investments as of September. That success will reverse in 2019.

Since its inception in 2017, the fund has invested at optimistic-looking valuations. Take WeWork, the money-losing office sublessor. The Vision Fund and SoftBank invested at a $20 billion valuation in 2017, according to the Wall Street Journal, or 13 times 2018 sales using Moody’s Investors Service estimates. SoftBank bought chip designer ARM in 2016 for around $31 billion and transferred a stake to the fund.

Those prices might make sense to Chief Executive Masayoshi Son, who touts his 300- year investment vision. But they look toppy through the lens of traditional venture-capital and private-equity methods, which SoftBank says it uses. The enterprise value of IWG, WeWork’s listed competitor, is just below one times its 2019 sales, using Refinitiv estimates, making WeWork’s multiple look stratospheric.

ARM’s valuation is set to suffer from a recent tech selloff and a slowdown in sales of Apple’s iPhones, which contain its chip designs. Shares in semiconductor rival Nvidia, in which the Vision Fund also owns a stake, fell more than 40 percent in the two months to Nov. 30. That has left Nvidia’s enterprise value at about seven times estimated 2019 sales, using Refinitiv data. Even at a generous 50 percent premium, debt-free ARM would be worth about $24 billion using Bernstein’s 2019 sales estimate, one-fifth less than SoftBank’s acquisition price.

Venture funds take writedowns all the time. Yet SoftBank is unusually vulnerable. Its size means marking down holdings could create a domino effect. The Vision Fund is also using debt, which totalled about $5.6 billion in September, to help fund its activities. Its capital structure unusually also includes preferred instruments, amplifying losses for other investors and requiring it to make cash distributions.

Moreover, Son’s partners, including Saudi and Emirati sovereign-wealth funds, might take fright at writedowns. Any losses risk undermining Son’s investing logic, which includes the notion that huge investments in emerging tech stars in and of themselves improve the chances those companies become winners. Both providers and recipients of funds, as well as investment staff, could lose faith. That would slow Son’s momentum and force him to think about the shorter term for a change.

First published Dec. 17, 2018.

Activism anxiety will grip French establishment


France knows a thing or two about meddling investors. The government regularly sticks its nose in private industry’s affairs. Moguls like Vincent Bolloré have long thrown their weight around public boardrooms at home and abroad. But few large French companies have undergone the cage rattling that regularly rocks their American cousins. Pernod Ricard, the booze group, got a taste of that when Elliott Advisors turned up with a 2.5 percent stake on Dec. 12. More is coming.

Executives of enterprises included in the benchmark CAC-40 index can partly blame President Emmanuel Macron for their rising activism anxiety. As economy minister in 2015, the former Rothschild banker ordered a stealth stake increase in carmaker Renault to double the state’s voting rights. That not only legitimised hedge-fund style manoeuvres in Parisian capital markets. It also set the stage for the current standoff with Nissan, in which Renault owns a large stake.

Similarly, attempts to take control of Telecom Italia by Vivendi not only backfired in 2018, they signalled vulnerability up the chain of command. Bolloré owns 25 percent of the media conglomerate, which may be worth about 30 percent less than the sum of its parts. A breakup could unlock that discount.

Investors could also gain by lobbying Renault to sell its 43 percent stake in Nissan. The shareholding is worth $16 billion, almost as much as Renault’s total market cap of $20 billion. The arrest of Chairman and Chief Executive Carlos Ghosn in Tokyo exposed a disparity in governance between the two partners. Should that lead to a rupture in the automakers’ alliance, investors will pressure Renault to release money tied up in Nissan.

Then there’s Danone. The 44 billion-euro yogurt juggernaut has no controlling shareholder and has underperformed rivals Unilever and PepsiCo, its one-time predator, for five years running. Or Saint-Gobain, whose shares have trailed those of Asahi Glass over the past half-decade. In late November the 18 billion-euro building materials group rushed out a plan to accelerate asset sales and cost savings — a telltale sign of boardroom agitation.

In the past, the French establishment has closed ranks to protect domestic champions from unwanted foreign intruders. Yet whether it’s in glass, cars, music or dairy, corporate France needs to brace for an activism unlike its home-grown variety.

First published Dec. 12, 2018.

Facebook might be the JPMorgan of the tech world


If Facebook can negotiate a difficult year ahead, it may be on its way to becoming Silicon Valley’s version of JPMorgan. A decade ago, financial firms were taking a whipping from politicians, just as tech companies are today. As Jamie Dimon’s bank shows, those who survive the process can end up even stronger.

Mark Zuckerberg’s social network faces a world of pain from Washington in 2019. A new Democratic majority in the U.S. House of Representatives has tougher privacy rules on its agenda. Several Democrats want to see those modelled after Europe’s new data protection law, known as GDPR. Facebook’s stock has tumbled, partly because of the Washington spotlight.

Now think back to the period after the financial crisis, when Congress was drawing up onerous Dodd-Frank legislation designed to make banks safer. JPMorgan was the poster child for bad behaviour. It faced a renewed backlash after a $6 billion trading loss in 2012, and paid $13 billion a year later for mis-selling mortgage securities. Dimon’s bank had to hire thousands of additional compliance personnel.

Yet now, JPMorgan is back on top. Dimon is head of the Business Roundtable, a Washington group made up of the chief executives of the largest U.S. companies. And its market capitalization of around $370 billion is almost twice its peak before the crisis hit. Meanwhile, community lenders’ share of U.S. commercial banking assets declined at a faster pace after Dodd-Frank was passed in 2010, according to a Harvard study.

Banks have advantages that social networks don’t — governments need them to exist, for starters. Yet there are still parallels with tech. About 60 percent of companies said they plan to spend at least $1 million to comply with GDPR, according to a recent survey by PricewaterhouseCoopers. At around $400 billion in market capitalization, Facebook can keep up far more easily than the average startup.

That’s not to say 2019 will be fun. Facebook’s growth in North America is flat, and lawmakers will insist on grilling Zuckerberg and his peers in public — which is tough because he lacks Dimon’s charisma. Even if a divided Congress can’t pass substantive laws, Europe might. But if doing so puts a moat around companies like Facebook they could come out even tougher.

First published Dec. 17, 2018.

Italian banks to bear populism’s burden next year


May 27, 2019. It’s 6:25 a.m. on the U.S. East Coast. Mike P., a portfolio manager at Boston’s OMG Capital, messages a dealer contact in Milan via WhatsApp after checking the markets on his Eikon app.

First published Dec. 21, 2018.