A trifecta suddenly points to higher interest rates
Yesterday the ASX200 drifted lower as a 0.7% advance from our banking sector was not enough to offset active selling in both the resources and healthcare sectors. Very quickly we’ve seen the rotation from resources to banks take hold in the market, with BHP set to open today around $26.60 / over 4% below this month’s high, while the recently out of favour CBA is now almost 5% above last week’s low, which was also the low for 2017.
The major change in sentiment has been around interest rates and we believe this has further to run through 2017 / 8. The MM Growth Portfolio is currently holding 40% in Australian banks compared to their market weighting of only ~25%, in other words we are 60% overweight the banks and importantly happily so!
The overall ASX200 index remains neutral as its 17th week of trading between 5836 and 5629 comes to an end. Overnight we saw markets totally ignore North Korea / Kim Jong Un who threatened to use nuclear weapons to “sink” Japan and reduce the US to “ashes” for supporting the latest UN sanctions. The Fear Index (VIX) has given up all of its worries around this geo-political issue, it’s amazing how often stock markets focus intently on an issue day to day for a period only to totally ignore it a few weeks later.
ASX200 Daily Chart
US Fear Index (VIX) Weekly Chart
US Stocks
US equities had another quiet night with no great points of interest. We are very cautious US stocks at current levels but would need to see a pullback / close under early Novembers 2490 low to generate some sell signals from a technical perspective i.e. only 0.5% lower.
Overall there is no change to our short-term outlook for US stocks where we are targeting a ~5% correction i.e. a further 130-points for the S&P500.
US S&P500 Weekly Chart
European Markets
Last night the UK FTSE fell 1.1% to its lowest level since May, an eye catching move as the local ASX200 is often very correlated to the FTSE. However, there was local news which assisted this drop as the Bank of England signalled the possibility of stimulus reduction moving forward. We still see another 4-5% downside for the FTSE.
UK FTSE Weekly Chart
Over the last few days the economic picture has been transformed dramatically by 3 separate and unlinked events:
1. Yesterday’s Australian employment data was very strong, adding over 54,000 new jobs in August, implying all is not as bad as many feared with our local economy.
2. US inflation surprised on the upside coming in at 0.4% for August, assisted by fuel costs.
3. The Bank of England’s rhetoric last night sent a strong signal on looming interest rate rises.
A number of traders are now looking to late this year for a 0.25% rate rise in the UK as they look to join Canada and the US in the rate increasing club – Canada has already raised interest rates twice since July alone. Locally the RBA is walking on a tightrope as they’re probably keen to increase rates in 2018 but fear 3 standout consequences:
1. Higher local interest rates may send the $A much higher than its already strong 80c, harming our competitiveness on the world stage.
2. Local house prices already feel precarious at current levels and a significant correction would harm consumer confidence and potentially cause a negative ripple effect through our economy.
3. Australians are already sitting on record debt levels, if the interest rate and hence repayments increase too fast the economy may be choked before it even gets going.
We remain very comfortable with our view the Australian and global interest rates are set to rise - we are targeting ~2.5% for the local 3-year bond yield i.e. 0.5% higher.
Australian 3-year bond yields Weekly Chart
As most of you hopefully know by now we are bullish banks from current levels assuming asset and primarily housing prices do not fall too far / too fast – banks margins improve in a higher rate environment. While we do not believe that housing prices / stocks should ever be compared to bitcoin as an asset class the 33% drop by the crypto currency over the last 2 weeks should be a warning that global asset prices are very elevated, and this appreciation has been significantly helped by historically low interest rates which are slowly starting to increase.
Bitcoin Currency (XBT) Weekly Chart
We’ve discussed at length recently the impact of higher interest rates on the likes of banks and “yield play” stocks but one area we’ve not mentioned is the popular and “highly owned” healthcare sector. Yesterday we received a question from a subscriber asking why Ramsay Healthcare (RHC) was so weak, a question we thought should be touched on today.
High interest rates usually have a negative impact on the healthcare sector and unfortunately our views are not too encouraging:
1. We remain negative RHC targeting the mid $50 area, over 10% lower. The stock is trading on a high valuation which is not too compelling as interest rates rise. Plus, the stock is very owned / popular which could easily add to its recent underperformance.
2. The US healthcare sector has reached our target which has been in place for ~2-years. We are neutral / negative eventually targeting a 20% pullback.
We’ve generally avoided the sector over recent months with the exception of our 5% purchase of Healthscope (HSO) which is currently ~3% underwater – we are watching this position carefully considering our view of the sector.
Ramsay Health Monthly Chart
US S&P500 healthcare sector Quarterly Chart
Conclusion (s)
We continue to believe global interest rates are set to rise which should be positive banks while housing prices hold firm but bearish both the “yield play” and healthcare sectors.
Overnight Market Matters Wrap
· Flat equity markets and mixed commodities point to a steady to slightly firmer opening this morning on the Australian market with talk of further global rate hikes once again weighing on sentiment.
· In the UK the Bank of England for the first time flagged a potential rate hike within months after their policy meeting. In the US an inflation reading of 0.4% once again raised expectations of a hike before the end of the year.
· Commodities were mixed after yesterday's slightly weaker than expected China data - retail sales industrial production and fixed asset investment - with iron ore slumping over 3%. Both BHP and RIO were around 2% lower in us trading while gold firmed. The A$ hovered below 80c.
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.
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