Used in isolation, the study below tells me to to ponder a couple things;
buy and fix my term deposits and/or
leave borrowings as variable. In other words, don’t lock them in.
When coupled with other observations in government bond yields and deflating commodity prices, it should (already is) lead towards lower inflation and GDP readings…….hence interest rates in the money markets should moderate by a 1% or little more, depending on the maturity you are watching.
For example, the Australian 2 year bond yield may decline from its current 3.58% to around the 1.80% region.
While the 90 day bank bill may ease from 3.47% to 2.40%.
The Reserve Bank of Australia policy changes will come many, many months later, for they are not a leading indicator nor a barometer.
Combined with my other studies and analyses, it’s price action is filling me with conviction.
Much like the S&P 500 (as written in an earlier post today), the ASX 200 has been trend less over the past year.
While this post-mortem validates my opinion that it would be a stockpickers market, invariably this has also left passive, index huggers wondering why adequate returns haven’t been easy to come by.
In the price chart below, the ASX 200 is yet to break the high seen in late January 2023.
That high remains below the high registered almost 2 years ago, in August 2021.
Furthermore, the recent March 2023 low was lower than its January 2023 low.
And the recent peak of 7,391 was not higher than the early February 2023 high of 7,568.
So we have a series of lower highs and lower lows.
For a bunch of reasons, it’s not a market which suggests piling into.
Indeed, there are times when to sell Australian bank shares.
This study below shows moments when the stock price in Commonwealth Bank of Australia (CBA) was stretched.
Ignoring such signals means investors are leaving money ‘at risk’ when probability suggests valuations are full or lower prices beckon.
Irrespective that Australian banks have always traded at a premium to their global peers, resting on the mantra that ‘you can’t go wrong owning the banks’ is false.
And finding solace, that ‘at least I’m receiving my dividends’ is not addressing the risk being taken for such a return.
CBA”s stock price is now trading at the same price as March 2015 (that’s 8 years ago) while Westpac is trading at the same price as 2008, 2010 and 2012.
I keep reiterating that what is more important about where interest rates have traded up to isn’t about the nominal rate, but rather the quantum or factor which the nominal rate have risen by.
Yes, the numbers look bigger when rates are rising from 0.5%…..but people, households, companies, governments etc etc don’t necessarily temper their borrowing when rates are low…..We tend to become accustomed to the ‘going rate’.
In general, the piggies are always at the trough.
When a family is seeking a mortgage of $600,000 but their credit provider announces the good news that they have been approved for $680,000, I suspect that they accept all of the $680,000. After all, they can use it for the landscaping etc etc.
We are happy to continue taking as much we can get or is available.
If my mobile phone plan allows for 20GB of data, I’m sure I’ll use it up and then ask for an upgrade to 40GB. Soon after, I’ll be requesting for an upgrade to 60GB of data.
When the Australian cash rates were 0.25% in last 2020, I was asked if I thought the Reserve Bank of Australia would cut rates at the next meeting.
My response was, “who cares”. The questioners were often shocked by my seeming flippancy.
At this point, I would add by asking, “How much debt do you have and how pressure are you under, that you need a further 15 or 25 basis points of relief”.
Today, if your cost of borrowing has risen from 3% to 6% and you are now speculating whether interest rates go up a further 1% receives the same response from me with the difference being, are you still carrying so much debt that you may ‘break’.
Is it the Fed that is possibly going to ‘break something’ or have we simply kept taking on more debt?
In the graphics below, you can see where the citizens of various nations sit in the indebted stakes.
Look at those frugal and financial responsible Latvians and Hungarians.
Household Debt as % of net disposable income source: OECD
Let me get back to the illustrating the ‘factor’ of the rise.
When rates went from 6% to 8%, it was only a 33% increase.
When rates went from 8% to 16%, it was ONLY a 50% increase.
Mortgage rates in Australia have nearly doubled. In the U.S., they have easily doubled.
The U.S. 2 years Treasury Bond yield has risen 10 fold.
When your interest repayments or the total cost of capital increase by such a factor, it is the quantum of the rise from the previous levels where you were comfortable with, that hurts the most.
My studies show that government bond yields have never risen by factors of 3 or 4 from their lows within any credit cycle.
At these extremes, as the chart within the below shows, the 2 year bond yield is miles above its 200 week moving average.
Why doesn’t mean reversion matter now, when it has many times prior?
Expecting rates to go higher and challenge gravity, probability and mathematics is a very foolish and crowded trade.
This is not about calling doom and whether the Fed ‘breaks something’……but rather it’s about thinking independently and reading the market tape as it is.
Behind the talk of where rates go to, sits speculative or investing opportunity.
If you have a view….then make the trade and take a position.
Those who shorted bonds when rates were 1% have made a fortune.
Today, if you think rates go up noticeably more……enough to tempt you into a trade, then short bonds and ride the expectation of whether the Fed keeps hiking rates to a point where ’they break something’.
If you think interest rates will fall, you could buy bonds.
Although, this is not a binary choice and the bond market may not be your natural business.
You can express you trade idea in many different manners.
For example, if interest rates keep rising, then you could short the equity of heavily indebted companies or technology stocks which aren’t profitable and have negative free cash flow, or
If you think rates are going to decline, then perhaps owing shares in high growth companies may see their prices ‘catch a bid’.
Of course, this is not personal advice and it’s important to do your research and analysis.
Opening gains in stocks are being given up as the past 2 days of trading is occurring.
Pessimism is growing amongst a host sentiment and survey indicators.
Really long term mean reversions are occurring or nearing.
Smaller investors seem jittery.
The AUD/USD is plunging. A visit to 0.6320 would be a 3 standard deviation event.
On September 9th, 2022, I wrote;
“I think prices will jump a little, drag in a few more people and then spit them out again in the coming week or three followed up with another swoon.”
For a bit of sport, I think S&P 500 has a terrible day during Wednesday’s session and the Aussie market will give up its early gains then sink further on Thursday before traders swoop in and start buying 2 hours before Thursday close not before they dump the same stock into Friday’s close before their long weekend on the Australian east coast.
As much as I dislike the time spent speculating on such a definition, if I’m forced to pass an opinion, it’s looking like a mid cycle slowdown.
Irrespective, businesses adjust and we trade through the cycle.
Over the past 40 years, studies show that recessions are officially registered somewhere between 18 months and 22 months following the inversion of a country’s yield curve, being when the difference between the 2 year and 10 year bond yield trades into a negative percentage.
The jury is still out whether the 5 year minus 3 month yield is a better indicator to watch.
So back to the traditional 10 year minus 2 year…..and unlike the United States, the Australian yield curve is not inverted.
The red line in the chart below represents 0.00%.
The two things occurring which I think will invert this curve are;
1) an overzealous Reserve Bank of Australia hiking rates too much trying to correct the overly accommodating and subsidising government fiscal policy errors and;
2) a government which cuts off the nations (commodity supply and capacity) ‘nose to spite its own face’ by crimping production and export of gas, coal, iron ore and other minerals.
My inadvertent political comment is pointed towards the recent ‘sudden’ and ‘rushed’ coincidence of Australia’s Prime Minister electing to visit the Glasgow COP26 climate event aligning with the subsequent release of a (albeit feeble) net zero climate policy in order to support his reason to ‘show face’ at the event.
Imagine being a political eunuch showing up to a pro-climate change conference without a pro-climate change position.
The poor soul faces an almighty dilemma.
The consequence of his absence at COP26 (as the leader of a nation which is the 2nd largest per capita carbon emitter) would be palpable.
Although having a firm view on global warming (notice how we don’t call it that anymore) and setting an appropriate policy carries a risk, for it has been the re-election downfall of the past 4 Australian Prime Ministers.
But all is averted……
Furthermore, in the coming week, fully vaccinated Australians can now depart Australia much more freely and return from international travel without the need to quarantine.
What a wonderfully coordinated convenience for the travelling ministerial delegation to Glasgow.
There is nothing illegal here, but it’s just a prompt to be aware of how things are framed and presented.
rob zdravevski's blog 