There are many traps and misnomers abound in equities and not all them are in stocks which are considered sexy and exciting.
Many companies raised money in 2020. This means capital structures have changed.
In one example, in 14 months, the stock price of Australian listed Oil Search (OSH.ASX) has nearly halved but the company is trading at a higher EV/EBITDA multiple.
The first graph illustrates the spread between yields of the U.S. Government 2 year bond and 10 year bond.
Today, the yield spread between the 2-10 year bonds is at its highest (1.08%) since April 2017…..but doesn’t mean much other than a financial news headline.
The second graph shows the history of the same spread over 45 years.
I say……until the 10 year bond is yielding more than 2% above that of the 2 year bond…….then there is no recession in sight and the ‘dance” in equity markets continues.
Today, commentators are rejoicing that Brent has returned to its January 27th, 2020 “pre-pandemic” price,
and that Brent has nearly tripled from its April 22, 2020 intra-day $16 low. (p.s. the Russian / Saudi stoush broke on March 6th, 2020)
but I think it continues its march higher.
In the past week, Brent rose 8.3%,
thus I’m revising and lowering the probability of a mean reversion to the $49 region (note: it remains probable, but less so in the near-term),
although I’m not a buyer of Brent Crude at these levels (for my risk-reward mathematics have changed),
I remain a long-term oil bull (based on my declining supply/capex thesis),
so keep in context that any decline remains one within a rising long-term trend,
while my price action and trend analysis suggests a price of $70 is plausible in relatively short order,
a price of $84 would be where I’ll highlight an important peak.
Incidentally, this week we’ll see the U.S. CPI monthly release and more relevantly, next week’s PPI figures are announced for January 2021 will help tell us if rising oil prices have worked their way into the inflation figures.
Measured investment professionals invariably know when “not to be in something”.
This means that we see parabolic moves often but equally don’t participate in any gains.
Devoid of commentary about fundamentals, we also don’t have our “faces ripped off” during the decline.
Aggressive wording perhaps, but I fear stories are yet to emerge of bored, young men (they are most susceptible to addiction) sitting at home, armed with a trading app, using leverage, not quantifying risk or not sizing their bet appropriately, are now staring at a 80% loss in GameStop.
It’s $90 today. Many bought stocks days go at $470. 😩
The combination of ‘unnatural’ participants in selected stocks or assets with prices which double, treble and then halve (and more) is not seen at the beginning of an overall bullish move.
This daily illustration has narrowed the time frame to the past 3 years and my annotations shows us when the S&P 500 (indexed to 100) is trading at a ‘stretch’ versus the AUD/JPY (a favourite currency risk indicator).
Today, this spread (of the S&P 500 over AUD/JPY) is at its highest in a few years. Readings above 38% portend a notable decline in the equity index.
Here is a story when the S&P 500 changed its risk profile.
Half way through 2013, the S&P 500 decided it would no longer honour, let alone couple with its old ‘risk’ companion…..the AUD/JPY currency cross.
So what gives?
Does the S&P 500 need to fall sharply in order to ‘re-couple’ ?
Well, there isn’t any rule which suggests so.
I’m merely pointing out an extreme.
Equally, it seems unlikely the AUD would strengthen against the Yen, for if equities declined notably, the safe-haven Yen would be bought and the risk ‘associated’ AUD would be sold.
So, there goes your spread trade theory.
Let the dance continue for now, but the multi-year bet is for equity risk premia to converge.
More on the near-term picture in a moment.
February 1, 2021
by Rob Zdravevski
rob@karriasset.com.au
In mid-2013, the S&P 500 (in orange) diverged from its symbiotic risk romance with the AUD/JPY (in blue)
While many of my indicators are either confirming (or near doing so) a turn lower in many asset prices…..ranging from Copper, Soybeans, Wheat, Corn, Coffee, Australian Dollar (vs USD & JPY) and the S&P 500.
Albeit I have already positioned portfolios for a decline (by moving to 35% cash and additional index and specific stock put option hedges)……
rather than speculating on the myopic business of ‘shorting’, my guidance is to prepare acquiring securities in sectors which will present attractive risk/reward opportunities.
Some industries to watch include Oil, Gas and Insurance, to name a few.
I’m re-iterating to clients that I am not lacking investment ideas. It’s more of a function of which ones to exclude.
I expect this pullback in equities to be shallow.
Spain’s IBEX and the U.K.’s FTSE 100 have already declined 8% from their January 10th high (a date which coincided with my “Cashing In Your Chips” note.
rob zdravevski's blog 