Market Matters Report / Market Matters Weekend Report – Inflation is what kills bull markets!

By Market Matters 21 February 21

Market Matters Weekend Report – Inflation is what kills bull markets!

Market Matters Weekend Report – Inflation is what kills bull markets!  

The ASX200 experienced another choppy week making new post COVID highs on Wednesday before reversing these gains in a poor finish, finally resulting in a net decline of just 13-points. The vast majority of the action in 2021 remains under the hood and it’s a trend MM believes will continue through until at least next year, 2021 is only 7-weeks old and while the index has eked out a small +3.1% gain we’ve already got over 10% of the market up or down by at least 20%, illustrating where the action is unfolding:

Winners : ARB Ltd (ARB) +24%, Westpac (WBC) +28%, Virgin Money (VUK) +28%, Bingo (BIN) +31%, IDP Education (IEL) +31%, Dominos Pizza (DMP) +24%, PointsBet (PBH) +35%, Zip Co (Z1P) +133%, Ingham’s Group (ING) +20%, Pro Medicus (PME) +38%, Lynas (LYC) +46%, News Corp (NWS) +25%, Afterpay (APT) +29%, EML Payments (EML) +22% and Vocus (VOC) +24% : 15 stocks.

Losers : NRW Holdings (NWH) -22%, PolyNovo (PNV) -36%, Nanosonics (NAN) -21%, Silver Lake (SLR) -23%, Resolute Mining (RMS) -25% and Westgold (WGX) -27% : 6 stocks.

A quick glance at the list above and I would think the market had advanced more than 3% but a little further examination shows that over 55% of the ASX200 is in fact down this year, historically it’s a warning sign when the broad market is struggling. MM believes the choppy price action will continue over the coming weeks as the market continues to remind / warn us that it’s been a while since it corrected over 10% although as we all know last February / March more than made up for it from a statistical perspective. The following points remain our current “Best Guess” road map for the year ahead, which of course by definition is fluid in nature but so far so good, its important subscribers understand our thoughts in what we believe will be an exciting year for prepared active investors. Importantly its often when themes remain consistent that investors become complacent and miss some important signals / catalysts, exactly what we are striving to avoid:

1 – We think the market will continue to chop higher over the next few months in a classic 3 steps forward, 2 back nature, a test of the 6500 area wouldn’t surprise us short-term but I still think the market will pop over 7000 in the not too distant future.

2 – The phrase “Sell in May & go away” exists for a reason, in the US May to September has been the weakest period for stocks going back all the way to World War 2. If stocks rally into this dangerous period, we will consider de-risking slightly but we must also remain cognisant that all statistics have anomalies and the current trend is clearly up.

3 – The major macro-economic tailwinds remain in play and while we feel they are diminishing as longer dated bond yields rally MM still believes 2021 should be a bullish one for stocks albeit choppy as the post GFC bull market matures slowly but surely.

My preferred scenario is the local market is trading above 7200 by Christmas but we’re likely to see plenty of stocks both soaring with the eagles and hanging with the turkeys. This is not a year to sit back and watch with a couple of heavyweights illustrating that the crowd might also struggle, so far this year the “Big 4 Banks”, Telstra (TLS) and heavyweight resources have advanced strongly while CSL Ltd (CSL), Goodman Group (GMG), Transurban (TCL) and over 60% of our IT sector are down.

MM remains bullish Australian & global equities over the coming months.

ASX200 Index Chart

Bond yields are the key to equity markets over the coming years in our opinion on both at the sector and index level, the scenario we’ve been peddling for at least last 6-months is unfolding very clearly with the following 3 points front & centre:

1 – Central banks might be holding cash rates at all-time lows but the markets pricing in a definite post COVID economic recovery and by definition inflation moving forward. In the US the differential between 10-year and 2-year bond rates is steepening almost daily as the 10-year interest rates are starting to test their pre-COVID levels – an illustration of how this impacts many Australians today is St George Bank have fixed 4-year year home loans on offer at 1.94% but 5-years kick substantially up to 2.74%, in other words the RBA is expected to lift rates after their promised 3-year holiday.

2 - A steepening yield curve typically indicates that investors expect rising inflation and stronger economic growth which on the sector level is supportive of the value stocks like Banks & Resources, exactly what’s been unfolding in the ASX.

US 2 & 10-year Bond yield Chart

3 – In the bigger picture bull markets don’t die of old age or because of excessive valuations, the later generally just leads to a correction. The two most common catalysts which herald the arrival of a bear market are inflation or deflation and with the central banks printing money like never before we believe its inflation and subsequently higher interest rate that will end this particular post GFC bull market. Both central banks and governments don’t appear prepared to see their economies endure prolonged tough times on their watch hence its full steam ahead on the stimulus front which will end in one of 2 ways either we get inflation and higher interest rates or the market will lose faith that the establishment can stave off a deep recession / depression – both are bad news for stocks.

The elevated volatility MM expects this year will probably unfold as investors swing between differing views around stimulus, economic recovery, inflation and bond yields – no easy equation mix.

MM remains bullish but does believe the 13-year old bull market is maturing like a good red wine. 

US M2 Money Supply (M2) Chart

Interest rates have been declining for 40-years meaning the vast majority of people involved in markets today have never experienced a bear market for bonds / a period of rising interest rates, just the occasional blip as the chart below illustrates. At this stage we aren’t necessarily calling a major seismic shift and the bear market for yields to be over but we aren’t ruling it out plus we do believe the risk / reward favours significantly higher rates over the years ahead e.g. if the Australian 10-years bounced back to just 2019 levels they would have to double from today which by definition create a significant headwind for equities and in particular those exposed to rising rates e.g. the IT, Healthcare, Real Estate and Utilities Sectors.

Bond yields have bounced strongly this year and a pullback wouldn’t surprise but at MM we are keener sellers of our growth plays into strength as opposed to the value ones, we still believe the markets underweight the local banks and some pockets of the resources hence buyers are likely to be disappointed as we feel corrections will be shallower than some hope.

MM is bullish longer dated bond yields.

Australian 10-year Bond Yield Chart

With regard to the Resources Sector we’ve have been discussing Mineral Resources (MIN) of late, at this stage we anticipate 2 likely scenarios over the coming 1-2 months:

1 – The current consolidation will continue and extend down towards $32 where MM would be a keen buyer.

2 – The stock will make fresh 2021 highs over $42 where we would be sellers from a trading perspective.

At this stage only the first scenario is likely to see MM tweak our Growth Portfolio but it’s a roadmap which should hold true for most of its sector peers.

Mineral Resources (MIN) Chart

The Australian Dollar ($A) has maintained its assault on the 80c level which MM believe will be scaled in the coming months, the question we continue to hear is when will it top out? The answer is similar and as tricky as with stocks, there’s plenty of medium-term resistance in the 80-81c area but the trends up and surprises happen with the trend, last week the $A tested its 2018 highs even while the $US was relatively quiet i.e. similar theory to rising bond yields MM is very cautious buying companies with significant $US revenue.

Importantly we believe inflation will raise its head moving forward which is fundamentally bullish the local currency hence our view is similar to stocks, stay long and monitor carefully.

MM is bullish the $A initially targeting a break of 80c.

Australian Dollar ($A) Chart

Not surprisingly as the market continues to unfold in line with MM’s expectations our plans & stance haven’t changed a great deal but as we touched on earlier we believe there will continue to be some quality switching opportunities beneath the hood, even if the index remains fairly stable.

1 Market Matters Growth Portfolio.

We are now only holding 2% cash in the MM Growth Portfolio following our recent moves therefore however bullish we are moving forward the next tweak is likely to be a sell or the very least a switch.

Hence today for obvious reasons I have looked at 2 stocks we are monitoring carefully with an eye on taking profit, this additional to the previous few we have mentioned over the last few weeks as “slow to sell” has been our Achilles heel in 2021 to-date.

1 Ramsay Healthcare (RHC) $62.16

Nothing complicated here, RHC has failed to embrace the “post COVID reopening” enthusiasm that many other stocks have achieved, its basically traded nowhere over the last year. Also being classified as a growth stock its vulnerable to the knock on effects of rising bond yields.

MM is considering selling RHC.

Ramsay Healthcare (RHC) Chart

2 Zip Co (Z1P) $12.35

BNPL top performer of 2021 Z1P is almost defining the word volatility in todays market hence although our target area is ~20% higher its certainly not out of the question for a stock regularly swinging over 10% per day.

Z1P is an amazing success story but another foray towards $15 and we will consider taking some profit.

Zip Co (Z1P) Chart

2 Market Matters Income Portfolio.

No change, the MM Income Portfolio was tweaked in late January, with our cash position sitting at just 2% its unlikely we will be switching / adding again in the near future.

3 Market Matters International Portfolio.

After selling Visa (V US) we now have a 11% cash position in the MM International Portfolio affording us the luxury of an additional purchase but at this stage of the cycle we are still more likely to top up an existing position & / or close out a position we aren’t happy with.

1 Zoom Video Communications (ZM US) $US417.26

No change, our position in ZM has been a bit of a rollercoaster post the pandemic but we now have a new environment as the vaccine is rolled out and competition intensifies. ZM might be ahead of the pack but its still priced for substantial growth with an estimated P/E for 2021 of 150x, were thinking it might be time to take our ~15% profit and walk.

MM is considering selling ZM into current strength.

Zoom Video Communications (ZM US) Chart

2 Wells Fargo (WFC) $US37.83

WFC enjoyed a great week and we believe the infamous fake accounts saga could finally be behind this large American bank which has heavy historical links to the Fed. We can imagine that sometime this year the market will enjoy the corporate regulator loosening the growth limitations on the bank, after all they could hardly overhaul the company anymore! Plus the technical pictures suggesting some good news might be in the offing.

MM is considering averaging WFC under $US40.

Wells Fargo (WFC) Chart

3 PayPal (PYPL US) $US286.92

We mentioned PayPal last week, the relatively new age payment gateway PayPal (PYPL US) has performed strongly in 2021 after gaining 16 million new active accounts in Q4 of 2020 alone!

MM is considering buying PYPL ~$US280.

PayPal (PYPL US) Chart

4 Market Matters Global ETF Portfolio.

No change, our cash holding remains at just 4%  MM Global Macro ETF Portfolio with our overall positioning of long equities with a focus on Resources & Banks coinciding with our reflation outlook plus elsewhere we are still looking for a global recovery and rising bond yields plus a weak $US.

Hence at this stage we are positioned for what MM believes comes next, if risk assets index do indeed rally over the coming months we anticipate becoming very active basically turning much of holdings on their head. However at this stage our likely next few tweaks haven’t changed significantly :

1 –  Take all / part profit on the Invesco QQQ Trust Series 1 ETF position.

Invesco QQQ Trust (QQQ US) ETF Chart

2 The VIX recently dipped under 20%  for the first time in almost 12-months, history says it will probably stay depressed for a while but we believe the VXX ETN shown below is in an accumulation area below 15 and will probably rally ~30% in the coming 6-months.

iPath Series B S&P500 VIX Short-term Futures ETN Chart

3 When we believe the markets risk / reward has tipped in favour of a correction one option for MM is the $US1.7bn SQQQ ETF which is leveraged around 2x to the market i.e. it goes up when the market falls and vice versa.

ProShares Ultra Short QQQ ETF (SQQQ US) Chart

Conclusion

MM is considering tweaking our portfolios around the edges but overall as we continue through reporting season we are positioned in accordance with our views.

Have a great Sunday!

James & the Market Matters Team

Our Holdings

Our positions as of Friday. All past activity can also be viewed on the website through this link. 

Weekend Chart Pack

The weekend report includes a vast number of charts covering both domestic and international markets, including stock, indices, interest rates, currencies, sectors and more. This is the engine room of our weekend analysis. We encourage subscribers to utilise this resource which is available by clicking below.

Have a great Sunday!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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