How the RBA Forces the Aussie Stock Market Up

Ed note: The latest Rum Rebellion market update is ready to watch. Please click here to view.

Normally, I struggle to keep my eyes open when Australia’s monthly employment report comes out. I usually look at the numbers, see how it compared to expectations, and go on living my life.

But now that the omniscient RBA is targeting the unemployment rate to try and fire up inflation, it’s worth taking a closer look.

Yesterday saw the release of employment data for May. The economy created 42,300 new jobs, versus expectations of 16,000. The quality was poor though. Of the new jobs created, only 2,400 were full time.

Despite the overall increase in employment, the unemployment rate remained at 5.2%. That’s thanks to the participation rate increasing to an all-time high of 66%.

In the RBA’s mind, then, further rate cuts are still on the table, because the unemployment rate is still too high to put upward pressure on wages, and therefore general price inflation.

But let me ask you, why is the participation rate at record highs?

Greg Canavan’s Top Three ASX Gold Stocks for 2019

The usual story is that when the economy is in good health, people are confident of finding work and therefore actively go looking for work.

But the economy isn’t in good health, is it? That’s why the RBA cut rates last week to historic lows of 1.25%.

Either the economy is stronger than what everyone thinks, or there must be another reason.

Perhaps the sluggish economy, and the hangover from the recent housing correction, has forced indebted households to look for more part-time work to help pay the mortgage and the bills?  That would be a rational explanation.

And if that’s the case, the RBA will be cutting rates more this year.

That’s what the market is telling you, too.

In yesterday’s essay, I told you to ignore people’s opinions and listen to the market. In the case of interest rates, the market is betting on more to come.

The chart below is from the ASX. It uses interest rate futures to show the implied pricing of the 30-day interbank cash rate.

ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve As at market close on 12th June 2019 14-06-19

Source: ASX

[Click to open in a new window]

As at 12 June, futures markets were pricing in a 53% chance of an interest rate cut at the July meeting. (That’s why the July blue bar is halfway between 1.25% and 1%.) By September of this year, another rate cut is a done deal, with another one more than 100% priced in by April 2020.

But enquiring minds want to know whether this aggressive interest rate forecast is in response to expectations of a weak economy, or an RBA now fixed on the unemployment rate, which might be very hard to budge.

To answer that question, you have to look at longer-term rates. The 10-year government bond yield is currently trading around 1.4%. This is only slightly above the cash rate. This is not normal. The 10-year bond yield tells us the Aussie economy is structurally weak. Expectations for more cuts to the official cash rate reflect this.


Aussie bond market to slowdown

If interest rate markets are correct, what do equity markets think they’re doing trading at multi-year highs?

The short-term reaction is easy to explain. Capital is flowing into the equity market in order to chase yield. You can’t sustain a retirement from the income in fixed interest, so you need to roll the dice in stocks.

In my view, that’s the primary driver behind the recent stock surge. And it has a fundamental justification in that rock bottom interest rates make equities look reasonably valued here.

This justification is fine…as long as company earnings hold up. This is the keystone of this whole stock market rally. If earnings continue to show resilience, the rally can be sustained.

As I showed you earlier this week, strong nominal economic growth rates are sustaining earnings right now. But the bond market is saying this cannot continue. If the bond market is correct in its assessment, then you’re going to see earnings downgrades start to flow.

It’s not just the Aussie bond market that sees a slowdown ahead. It’s the same all around the world. US 10-year bonds currently yield 2.09%. The three-month bill yields 2.17%. In bond market parlance, this represents an ‘inverted yield curve’. This occurs when the long-term cost of money is cheaper than short-term rates.

That’s not normal. It suggests that economic growth in the US is set to slow sharply. If the curve remains inverted, it increases the chances of the US going into a recession.

That explains why the large US tech companies that I profile in my latest video update are all showing signs of running out of share price steam. Make sure you watch it, because it seems like the Aussie market is ignoring signs of an impending global slowdown.


Greg Canavan,
Editor, The Rum Rebellion

PS: In an exclusive new video interview, Greg Canavan talks all things gold with Richard Hayes, CEO of The Perth Mint. Click here to watch.

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

Learn more about Greg Canavan's Investment Advisory Service.

The Rum Rebellion