Morning Report / The interest rate train has just left the station!

By Market Matters 15 November 16

The interest rate train has just left the station!

Market Matters Morning Report Tuesday November 15th 2016

The market trends since the US election continued unabated last night, adding weight to our view that some major inflection points have occurred. Three things caught our eye last night and they have large ramifications for our local stocks:

 

  1. The US banking Index soared over 3% to reach its highest level since mid-2008.
  2. US 30-year Bond interest rates traded over 3%, reaching their highest level in 2016.
  3. The $US Dollar Index rallied 1% to break the 100 level for the first time in 2016.

As members of the Market Matters family, you know we have been targeting the rally from the US Banking Sector for over 6-months and Mr Trump’s victory has swept us there very quickly with an amazing 14.8% gain this month alone! This rally is being fuelled on two fronts – Firstly, rising long-term interest rates is positive for bank margins / profitability and secondly, Mr Trump’s pledge to reduce onerous and costly regulations is great for the sector. Our target for the US banks is now only ~5% higher.

CBA has gained 3.8% so far in November, about a quarter of the gains of its US counterparts - ANZ, NAB and WBC have all traded ex-dividend this month and are hence not a useful comparison. Ideally, our local banks will regain their "Mojo" into Christmas with our ideal target for the sector 6% higher.

We are currently long CBA, Macquarie Group (MQG) and Westpac (WBC). We ideally plan to sell our WBC holding between $32-33 region, prior to Christmas.

US S&P500 Banking Index Monthly Chart

 

Last night 30-year bond interest rates hit 3%, reaching their highest level in 2016. It should not be underestimated that global interest rates have been falling for ~30-years and at a minimum, we are likely to be witnessing a significant bounce towards 4% i.e. interest rates 30% higher than where they are today. The RBA cash rate which is 1.5% today was at a very scary 17% back in 1990 - never underestimate what markets can do in both directions. At some point in the relatively near future, we believe the prospect of rising interest rates will put stocks under pressure, but not yet.

 

Two big elections are looming in Italy and France, they feel very 50-50 after BREXIT and Donald Trump. If the current governments lose these elections, it will very likely lead to the respective countries leaving the EU and in the short-term, money flowing back into safety of bonds, pushing interest rates lower. This is a very real risk to the recent market trends, but the French election in mid-2017 is likely to far more important than the Italian referendum in early December. Assuming stocks continue to rally into 2017, we would not advocate being over exposed to stocks into the French election / mid-2017.

US 30-year Bond Interest Rates Monthly Chart

The $US looks poised to make fresh multi-year highs in coming days / weeks. We have been calling this move followed by failure and a 10% drop in the $US.  However we are reviewing this, at least  short-term.

  1. When Ronald Reagan came into power and started spending, the $US rallied an astonishing 45% in his first 4 years.
  2. US interest rates rising should be positive for the $US.
  3. If either of the European election risks come to fruition over the next 6-months, the $US should again rally becoming a safe haven away from Europe.

Overall it's hard to see any negatives for the $US short-term, BUT we all know things can change.

Assuming Donald Trump starts spending quickly, inflation and US interest rates are likely to rise quickly taking the $US with it. Hence $US earning Australian stocks should be very well positioned over coming months e.g. Amcor, Cochlear, Resmed, Brambles, Ansell, CSL, Computershare, James Hardie, Henderson Group and Westfield Group.

$US Dollar Index Monthly Chart

Summary.

We remain bullish banks, but now anticipate our next move in the sector is likely to be taking profit on Westpac.

We continue to believe global interest rates are set to rally over coming years and hence like QBE that we bought yesterday - note we only bought 4% and we will average on any decent pullback towards $10.

Lastly, we are becoming more positive on the $US and now like Westfield (WFD) who receive 75% of the earnings in $US. The stock has now corrected 26% over the last 5-months and we believe now presents solid risk - reward. We are a happy buyer of WFD under $8.50.

*Watch for alerts today.

Overnight Market Matters Wrap

  • The US markets closed mixed, with Dow up slightly, 21 points to 18,869, while the broader S&P 500 unchanged at 2,164.  The Nasdaq 100 however lost momentum and closed down 50 points (-1.1%) at 4,702.
  • Investors are still pricing in the risk of unknown as we wait for further transparency on the policies from US President-elect, Donald Trump.
  • With uncertainty weighing, the bond market was the focus overnight.
  • The December SPI futures is indicating the ASX 200 to open marginally lower this morning, testing the 5,340 level.

 

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 15/11/2016.  8.00AM.

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