In late May I sent the following to subscribers of Greg Canavan’s Investment Advisory:
‘I think it’s simply a matter of ‘peak stimulus’ being behind us for now. A huge amount of speculative capital came into the market last year and into 2021 due to global pandemic-related stimulus. But like the pig in the python, it is moving through the system now and having a diminished impact.
‘As I’ve discussed on numerous occasions, “Life at Zero” isn’t all plain sailing. Markets won’t go up in a straight line. There will be frightening pullbacks along the way to higher and higher stock markets.
‘It is these frightening pullbacks that will ensure the authorities do something even more absurd down the track. This will further destroy the purchasing power of currencies.
‘The key to dealing with this is foresight. If you know there is an increased probability of something coming, you are in a better place mentally to deal with it. It also gives you time to position your portfolio for turbulence.
‘To be really clear here, I don’t expect things to go pear-shaped in the broader markets immediately. Major indices in Australia and the US are still in healthy uptrends. This could still take three to six months to unfold. I’m just alerting you to the warning signs.’
Earlier this week, I sent this:
‘This article in the Weekend Australian caught my eye:
“The four major banks are likely to announce $15 billion in share buybacks over the next year, with Commonwealth Bank to kick off the bonanza with a $5 billion deal at this year’s annual result, according to Morgan Stanley.
“Analyst Richard Wiles said in a note that the big four were sitting on $19.5 billion to $28 billion of surplus capital, based on a target common equity tier one ratio of 10.75 per cent to 11.25 per cent.
“Assuming an even more conservative target of 11.5 per cent, the excess would be more than $15 billion.
“‘We expect the banks to take a conservative approach to capital management in the near term given that COVID-related risks remain and the Australian Prudential Regulation Authority’s revisions to the capital framework are not yet finalised,’ Mr Wiles said.
“Despite this, CBA was likely to unveil a $5 billion buyback at the 2021 annual results, with ANZ, National Australia Bank and Westpac likely to follow up with buybacks of $2.5 billion, $4 billion and $3.5 billion respectively at their 2022 interim results.”
‘Here’s a rough rule of thumb…
‘Banks raise capital or cut dividends at the lows and conduct share buybacks close to the highs.
‘The buybacks haven’t been announced yet. But the fact that the banks are now generating excess capital means we’re closer to the top than the bottom.’
As a result, I recommended taking some money off the table in some banking stocks. We’ve been in that rally since October last year.
Here’s the problem that I see…
The Aussie economy is slowing after its stimulus-driven recovery. Yet the ASX 200 continues its climb towards record highs.
It seems to be having the best of both worlds. Resources moving higher because of the ‘inflation trade’ and banks/financials loving the low interest rate environment.
Meanwhile, the bond market is signalling a slowdown.
The chart below shows the Aussie 10-year government bond yield. Yields peaked all the way back in February at 1.85%. This was the height of the ‘inflation is coming trade’. And while that narrative is still intact thanks to a few months of favourable comparisons with last year’s deflationary conditions, the bond market is saying otherwise.
As the chart shows, yields have fallen 40 basis points in the past three months. The bond market is telling you (as I have been) that the inflation is transitory, and the economy is slowing.
Whether that means the market is set to drop from here is another question. The ASX 200 is trading at fresh all-time highs. The trend is bullish. Perhaps the narrative shifts to ‘low bond yields justify higher stock prices’ again.
Who knows? When the mood is bullish, the market will run with whatever narrative suits. But if the bond market is right, in the next few months you’re going to see weaker data and perhaps some comments about weaker operating conditions for companies.
It’s not just Australia either. The US 10-year bond yield is off its highs too. As the chart below shows, US yields peaked at the end of March (about a month after Australia) but now look like they’re heading lower.
As economist Dave Rosenberg wrote in his morning note:
‘Consider how much “bad news” for bonds there has been out there — massive inflation chatter, narratives of how stupid the Fed is, huge increases in commodity prices, what has been a weak dollar, unprecedented fiscal juice, record money supply growth, double-digit GDP growth, visions of infrastructure stimulus, widespread reports of wage increases, booming producer and consumer price data, the vaccination process coming so early and the economy pretty well re-opened. Not to mention all the action in equities, inflationary value-stocks in particular, and the entire risk-on trade. And here we are, with the yield on the 10-year T-note down 20 basis points from the nearby high. All a sign of how much “bad news” for bonds has already been discounted. It’s “in the price.” What isn’t in the price is a second-half growth relapse in the economy.’
Well, bond markets certainly look like they’re starting to price that scenario in.
Stock markets? Not so much.
Just something to consider as most investors remain blindly bullish…
Editor, The Rum Rebellion
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