Do NOT Touch These Two Aussie Banks

Dear Reader,

It’s not often a 3% decline in the US feels like a win. But we are indeed experiencing strange times.

With the effects of the coronavirus shutdown escalating on a daily basis, and the US futures opening ‘down limit’ (5%) on Monday our time, many feared another brutal session in the US.

But overnight, the Dow and the S&P 500 closed down around 3%, while the NASDAQ fell just 0.3%.

Gold, on the other hand, surged US$50 an ounce. It’s now trading back around US$1,550 an ounce. In Aussie dollars, gold surged to a new all-time high and trades around $2,670 as I write.

Gold responded to yet more Federal Reserve action overnight. From the Wall Street Journal:

Federal Reserve Chairman Jerome Powell’s whatever-it-takes moment arrived Monday.

The central bank signaled it would do practically anything—extending loans to big and small businesses, backstopping funds to municipalities and purchasing hundreds of billions of dollars of government debt—to help an American economy in a race against time.

The big question now is how quickly the Fed, working with the Treasury Department and awaiting a potential infusion of funds from Congress, can limit a deepening working-capital crunch moving across the economy.

That’s the question, isn’t it?

The world has never experienced anything like this. That is, the forced shutdown of the global economy due to an external threat.

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When money stops flowing…

Think of the movement of people and goods around the world mirroring the movement of money and credit through the financial system. When the movement of people and goods suddenly halts, the movement of money halts too.

But people still need to pay their bills. They still need to earn a wage. When money stops flowing, and certain goods and services are no longer in demand, that becomes a very difficult challenge.

Companies deal with working capital crunches all the time. But a whole economy? That’s a completely different ball game.

What is a working capital crunch?

Firstly, what is working capital?

Working capital is things like cash in the bank, inventories and accounts receivable (money owed to the business). These are offset by accounts payable (money the business owes to others), short-term debt and other provisions.

Over the years, many companies have tried to get their working capital position as lean as possible. That means keeping cash and inventory levels low, reducing accounts receivable and increasing accounts payable.

This has the effect of tying very little short-term capital up in the business. Doing so increases the overall profitability of a company.

This is great while the economy is running smoothly. As long as sales continue, the money flows through the working capital accounts and it’s all sweet.

But when the economy/money/credit flow stops dead in its tracks, you get a working capital crunch.

Cash is all of a sudden king

This is why the Fed is doing everything possible to ‘reliquefy’ the system. Its balance sheet will expand massively in the months ahead. There is no limit on how much it can grow. You’re going to see some crazy numbers.

The Fed is now buying all sorts of ‘paper’, not just US Treasuries. When it buys this paper, it replaces it with ‘cash’. That’s how it reliquefies the system. It will take some time, but it will work.

By ‘work’ I don’t mean make everything better. That won’t happen until the shutdowns end and the world gets back to normal. But it will stop the unfolding working capital crunch from seizing up the system completely, and putting even MORE people out of work.

While the Fed’s actions overnight stopped the market from a BIG fall, it still fell nonetheless. There is no bottom in sight. Not yet anyway.

In Australia, the market opened yesterday with a panic plunge. It was down 8% early. But stocks rallied during the day and finished down ‘only’ 5%. But it’s hardly bullish.

The market is expected to open higher today. But who knows where it will end up?

There is a lot of value emerging in Aussie stocks now. It’s just a question of how much more pain is in store. In a bear market, cheap stocks can always get cheaper.

And you have to be very selective of what you buy. For example, the Big Four banks have been absolutely hammered over the past month. Have a look at the chart below. It’s the ASX 200 Financials index. It’s sitting right on the lows from 2011.

Rum Rebellion

Source: Optuma

[Click to open in a new window]

The Big Four account for a decent chunk of this index. Looking at the Big Four individually, both National Australia Bank Ltd [ASX:NAB] and Westpac Banking Corp [ASX:WBC] have dropped BELOW the lows from 2009.

This is not a good sign. The market is seriously concerned about these banks. If you were looking to dip your toes in the banking sector, perhaps caution against adding these two.

At the very least, I would expect a capital raising might not be far off. And there will be dividend cuts too.

On the plus side, the banks have decided to be better corporate citizens during this crisis. That’s also weighting on share prices.

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Having said that, there is no such thing as altruism in markets. Money is amoral. If the banks wanted to play hardball, asset values would plunge and they would quickly become insolvent.

Thankfully though, their self-interest aligns with ours in this situation.

And that’s the wider point here. We all need to work together to get through this threat. It might take a few more months of lockdown and sacrifice, but I’m certainly looking forward to being on the other side of this.

Until tomorrow…

Greg Canavan,
Editor, The Rum Rebellion

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.

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