Market Matters Report / Market Matters Weekend Report Sunday 31st May 2020

By Market Matters 31 May 20

Market Matters Weekend Report Sunday 31st May 2020

Market Matters Weekend Report Sunday 31st May 2020

When will the “Fed Put” expire?

The ASX200 finished May up a respectable +4.2% as the stock market recovery post the coronavirus outbreak continues, if it hadn’t been for a bad close on Friday the gain would have been ~7%. Last week was all about the banks who came back into favour in a major way, the “Big 4” advanced an average in excess of 14%, a very influential move considering they represent over 20% of the ASX200. However, the buying still remained broad-based with only 10% of the ASX200 closing down for the week, even after Fridays sobering 95-point fall the market still feels healthy and at MM we continue to believe decent pullbacks should be used to accumulate targeted stocks.

MM remains bullish equities medium-term with the major driver remaining liquidity.

Last week we saw two more examples of stocks ignoring theoretically bad news, this time it was the very disturbing social unrest in Minneapolis as President Trump battles issues on a number of  different fronts plus China’s opportunistically timed yet inevitable move on Hong Kong, for all the worlds current bluster what did they think would eventually unfold once China regained sovereignty from the UK in 1997. Even the directly influenced Hang Seng managed to close out the week unchanged, there’s no embracing of bad news in today’s market.

On a side note I had to mention that China has tested 11 million people in Wuhan for COVID-19 in just 2-weeks! Numbers like this make it easy to comprehend how this efficient socialist state will remain the main economic driver of global growth in the years ahead – good news for our miners.

MM likes the Hang Seng into fresh 2020 lows, we will look to gain exposure accordingly through our International & Global Macro ETF Portfolios. 

Hong Kong’s Hang Seng Index Chart

Short-term we are unclear on our view for  the Australian market but the picture on global bourses favours a pullback in June / July hence we are comfortable not chasing the latest “pop” from the 5600 area. The action on the stock /sector level continues to rapidly evolve as investors try and second guess how fast and in what form the global economy will emerge from COVID-19 lockdowns e.g. I read an article in the AFR on Saturday titled “Bricks and slaughter as CBDs turn to ghost towns” it postulated that the Office REIT’s Sector may never fully recover, I probably agree to some extend as most people I speak to have loved working from home through the lockdown, however I suspect the change won’t be as dramatic as some are making it out to be- perhaps Lend Lease (LLC), a holding we have in the Growth Portfolio will get work converting offices to apartments, Bingo (BIN) another of our holdings would benefit via rubbish removal!  

At this stage I imagine MM will spend most of June looking for ways to tweak our portfolios around the edges, but never say never.

MM is neutral Australian stocks short-term.

ASX200 Index Chart

Our preferred scenario for the US S&P500 is we’re close to a 8-10% correction, not an outlandish call considering its already retraced 7.3% and 6.4% since equities major panic low in March. We have increased our cash position slightly to afford us the luxury of being aggressive buyers if such a pullback does eventuate. 

MM is a keen buyer of the S&P500 around the 2800 area.

US S&P500 Index Chart

The “Fed Put”

I was reading a Bloomberg article at the end of last week which mentioned the “The Fed Put”, a phenomenon which MM regularly mentions but has never attempted to fully explain – it’s also extremely important as we believes it’s driving stocks higher. By the end of this missive I hope all of our subscribers will understand this phrase and importantly its subsequent enormous impact on the share market – if we have succeeded by definition you will understand why we are both bullish into 2021 and understand envisaging moving to 50% cash at some stage in the next 18-months i.e. when we feel the QE taps being turned off.

Firstly, the picture below is the classic “time decay” chart of an option, calls & puts basically lose value gradually before plunging to zero over the last few weeks, a bit like the half-life of radiation for those who can still remember 101 Chemistry. Please note this is only the representation of the time component part of an option i.e. the price you pay to insure for the unknown /  “what if” scenarios. The Fed Put is a metaphorical name and its most definitely not a typical standardised option but it does remind me of such in 2 different ways:

1 – The Fed Put will slowly but surely have less influence on stocks over time as investors become fully aware of its nuances and market impact.

2 – When markets get a sniff that the “Fed Put” tap is being turned off its affect will rapidly vanish and history tells us it could spell trouble for stocks.

Time decay of an option Chart

Asset prices are dictated by one simple equation which boils down to supply and demand, the more tricky part of this relationship is determining who / what is making up these 2 intrinsic factors.  One of the largest determining factors for share prices is their relative valuation, if you can get say 5% risk free in the bank while a stock only yields 2% then for it to be worth considering capital appreciation needs to be a strong possibility. However when global interest rates are around zero the proverbial  bar for shares to look attractive is significantly lowered – the 2 charts below illustrates the cost of money has never been lower, in the US 30-year bonds are yielding under 1.5% while in Germany they are still negative, not much competition for shares in a valuation match-off – although bond  yields have recently doubled in the US it’s not a worry to us, yet!

The phrase the “Fed Put” is the general concept that the US Federal Reserve is willing and able to adjust monetary policy in a way that supports the stock market.

The Fed’s main goals are in relation to strong employment while keeping inflation in check. However, a stable economy, modest inflation and the stock market are by definition all closely linked. Undoubtedly the Fed and other major global central banks through Quantitative Easing (QE) and the lowest official interest rates in history are providing a very stable and supportive back drop for stocks and although it’s hard to envisage them throwing much more mud at this proverbial wall they appear determined not to let a prolonged recession unfold post COVID-19.

At some stage in the coming years we are going to see a market which is valued through more traditional matrices as QE is reduced and eventually withdrawn, the initial knee jerk might not be pretty – we saw what happened at the end of 2018 when the US Fed tried to raise interest rates.  However, it was only a few weeks ago the Federal Reserve Chair Jerome Powell uttered those most bullish of words “whatever it takes” with regards to maintaining credit and an orderly financial system. Even if they already feel it’s probably enough, I believe they will want COVID-19 well and truly in the rear-view mirror before taking the foot off the pedal.

In the bigger picture MM believes global bond yields have bottomed and interest rates will be noticeably higher in the years ahead, albeit it off an extremely low base.

US 30-year Bond Yield Chart

German 30-year Bond Yield Chart

The Fitch Ratings agency believes Global QE (asset purchases) will reach $US6 trillion in 2020 or more than half the implemented QE between 2009 and 2018, its simply been huge! In the last month alone, the US Fed has spent $US2.2 trillion taking its balance sheet up 50% to $US6.5 trillion exceeding Q1, Q2 and Q3 combined in the process. There are numerous ways at playing with these statistics, but the bottom line is the Fed and global central banks are going “all in” to avoid a deep recession, their action and rhetoric makes MM very comfortable buying shares at least medium term.

Through unprecedented QE the Fed is adding massive liquidity to the financial system and fuelling the Fed Put in the process.

QE is a relatively new or unconventional monetary policy where the central banks create currency to buy bonds to drive down their respective yields increasing money supply to encourage lending and investment i.e. liquidity. Since the pandemic we have seen record QE from the Fed and other global central banks which has even included the buying of corporate  bonds for the first time in history – liquidity in corporate bond markets has in the past allowed huge share buybacks which helped fuel the longest bull market in history, today its allowing companies to raise capital to shore up their balance sheets.

The Fed & central banks have created huge liquidity and hence demand while supply remains basically unchanged = bullish stocks.

In Australia we may have seen some major capital raisings (increased supply) but the way they were almost entirely healthily oversubscribed illustrates the massive cash sitting on the sidelines (excess liquidity).

The chart below which we showed a few weeks ago illustrates the huge correlation between the internal strength of the corporate high yield bond market and the S&P500, with the exception of the surprise pandemic outbreak the A-D  line has been trending lower as a great warning for equity investors before the road became bumpy i.e. the corporate high yield  bond market is very sensitive to liquidity, by definition when such liquidity dries up so does the demand side for stocks.

NB The A-D line is the advance / decline differential of high yield bonds hence a higher reading demonstrates strength.

US S&P500 Index v Junk Bonds A-D line Chart

To MM the “Fed Put” should really be called the “Central Bank Put” because stocks have become a global market but without picking hairs while the Fed’s buying / supplying liquidity MM simply believes investors should buy pullbacks. The junk bond ETF shown belowremains very supportive for equities, we do see some resistance in the current region, similar to stocks it looks and feels like June could give us a pullback for a buying opportunity but there are no sell signals.

Remember be on your guard, moves that would usually take months to unfold are being done and dusted in a few days!

iShares Junk Bond ETF (HYG US) Chart

Conclusions

1 - MM believes stocks should be bought / accumulated into any pullbacks while the Fed  / Central Bank Put is in play.

2 – Medium-term we believe bond yields will grind higher which should eventually help value stocks outperform growth.

3 – Bigger picture we believe bond yields have bottomed and central banks will withdraw their supportive QE in the next few years which should ultimately deliver some meaningful pullback in stocks.

3 stocks which caught my eye this weekend

We are continually trying to evolve and improve the MM offering, this is not necessarily going to be a permanent fixture but when things really catch my eye they should obviously be included in the Weekend Report – any features you miss, love or could without please let us know!

1 CSL Ltd (CSL) & Ramsay Healthcare (RHC)

MM has avoided the ever popular and complacently held CSL over the last few weeks, it would have been easy to buy the pullback but it’s kept slipping lower with talk of some analysts even paring back their numbers. We still believe this is a world class business, but our buy area remains 10% lower, not miles away after last week’s 5% fall.

Conversely MM holds Ramsay Healthcare (RHC) from below $62, we remain bullish initially looking for 6-8% higher.

We have made no secret that we are likely to remain underweight the Healthcare Sector for much of 2020 however we’re not adverse to switching our existing holdings, if the CSL-RHC spread contracts buy another ~$25 we will consider switching RHC to CSL.

CSL Ltd (CSL) & Ramsay Healthcare (RHC) Chart

2 Vocus Communications (VOC) $3.04

We simply believe VOC is an excellent well positioned turnaround story which is exactly what’s on the menu of many fund managers at present. Also following substantial insider buying earlier in the year coincidentally around current levels we see plenty of upside for the stock as we move on from COVID-19.

MM is bullish VOC at current levels with an initial target 20-25%  higher.

Vocus Communications (VOC) Chart

 

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 day!

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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