Stock price sale to continue

Tuesday, 7 November 2023

[4 min read]

Dear Reader,

Our Melbourne-based office is closed today for the Melbourne Cup public holiday.

So I thought I’d share with you an article I wrote for the Insider — a publication exclusive to Fat Tail paying subscribers.

As you know, the RBA meets today to determine whether to instill another rate rise. Read on for what I think the effect of this will be on our economy.

Enjoy…

Markets rebounded strongly last week.

The ASX200 jumped 2.2%. The S&P500 surged nearly 6%.

Locally, property trusts were the big winners. The sector added nearly 7% this week.

As an aside, I titled my latest monthly issue ‘REITS: The biggest (contrarian) opportunity in the market right now.’ The stock I recommended jumped 12% last week. The sector is very cheap if you think bond yields will continue to head lower.

More on that later…

But first, why did the market surge last week? And is it sustainable?

Let me answer each question quickly and definitively.

Why did the market surge? By the end of October, it was heavily ‘oversold’. Technically, it was always going to bounce. The rally started going into the Fed meeting last Wednesday. Then, the Fed added fuel to that technical fire by keeping rates on hold.

Is the rally sustainable? No.

At least, history suggests it’s not. As economist Dave Rosenberg wrote in a recent note:

‘The thing is, the average decline from the time of the pause to the ultimate low in the S&P 500 historically is -25% and the median decline is -20% — because economic erosion and declining earnings estimates are what causes the pivot.’

You tell ‘em Dave!

Don’t forget, the reason for the Fed’s likely pause is because of a slowing economy. That’s not going to be good for earnings.

And even a lagging indicator like employment is starting to show it.

On Friday, US non-farm payrolls data for October came in lower than expected at 150,000. The Bureau of Labor Statistics revised down the prior two months too. And, according to Bloomberg, the unemployment rate hit a near two-year high at 3.9%.

Expect more to come…

This news was, of course, bullish for the stock market.

Why?

Because it resulted in a sharp fall in bond yields. Since Tuesday, US 10-year bond yields have declined by more than 40 basis points.

The stock market thinks the fall in bond yields is bullish because lower rates are positive for stocks.

But it’s not bullish. The bond market is finally saying that higher for longer is starting to bite. And guess what? The Fed will stick with the higher for longer mantra. They’re not going to turn on a dime and start cutting rates.

They will keep rates at this level until they can no longer deny the economy isn’t in recession.

Here’s the problem for the US stock market…

Analyst estimates for 2024 put the S&P500 on a P/E of 17.7 times. That’s equivalent to an earnings yield of 5.6%.

It’s a reasonable valuation…but these estimates factor in a 12% increase in earnings per share in 2024. 12%!

That, to me, is a low probability outcome.

With no growth, the S&P500 trades on a P/E closer to 20 times. And if a recession does hit in 2024, earnings will fall. This pushes the P/E up again.

At 20 times, the earnings yield is 5%. That compares to a current US 10-year bond yield of 4.52%. The difference is a rough proxy for the ‘equity risk premium’. At 50 basis points, it is very thin. Historically, the equity risk premium is around 300 basis points.

So, from a broad ‘market’ perspective, US stocks remain stretched here.

But I do think bond yields have peaked for this move. They should continue to head lower as more evidence of a weaker economy comes in.

What about Australia though?

The Aussie 10-year bond yield peaked on 31 October at 4.99%. It ended last week at 4.72%.

The RBA meets tomorrow to decide on its next interest rate move. Markets and economists expect an increase. The rationale is that inflation is still too high.

Fair enough. But is another rate hike really going to help on that front? I mean, the government has opened the door to half a million immigrants this year. The economy doesn’t have the capacity to absorb those numbers in the short term.

The strength in housing has nothing to do with interest rates not being high enough. It has everything to do with demand outstripping supply. More and more income will go to this essential service, cutting back elsewhere to do so.

Meanwhile, another rate rise will boost the spending power of the already cashed-up baby boomers.

And then you have the real source of inflation in the economy — government spending. As you can see in the chart below, the COVID spending surge just hasn’t stopped.

State governments are the worst…

Spending like this puts pressure on scarce resources. Inflation is the inevitable result. Is another rate hike really going to do anything?

State and Federal Governments quickly need to scale back their spending. But when you’re using someone else’s credit card, that’s hard to do.

So, it’s the mortgage holder who will bear the brunt of the fight against inflation.

If the RBA does raise rates tomorrow, keep an eye on the moves in the bond market, especially the 10-year yield. Ongoing falls will suggest another rate rise will really hurt the economy.

From an investment perspective, that could mean yield sensitive stocks are the place to be.

But as always, have a focus on value. There are plenty of good stocks on the ASX trading cheaply right now. Notwithstanding the recent rally, they may get cheaper as the RBA fights inflation with a blunt instrument.

But the opportunity to buy good stocks at good prices doesn’t come around often. Don’t let the RBA distract you while the sale is on.

Regards,

Greg Canavan,
Editorial Director, Fat Tail Daily

[4 min read]

Dear Reader,

The White House has asked for $106 billion so it can be a part of the futile stalemate in the Ukraine and the mass murders in Israel and Gaza. The Israelis don’t need the money — they are among the world’s richest peoples. The Ukrainians merely waste it…with billions skimmed by corrupt officials and much of the rest making its way back to America’s firepower industry.

But though this spending is considered essential to preserving the peace and happiness of the world, nobody seems very eager to pay for it — at least not with honest money. No ‘war tax’ has been levied, neither in the US, Israel or even the Ukraine. There are no crowd-funding efforts on the internet. No government is cutting back on its butter to pay for its guns.

Nor will there be any pay-off from victory.

Making war used to be a profitable enterprise. You would steal land, gold, jewellery…and sell your victims into slavery. No more. Now, unless you are actually under attack, war is a losing proposition.

But let’s look back at those glory days…when war still paid.

Danegeld Tribute

The rich and fertile valleys of what is today Normandy must have been an appealing prize. Viking raiders must have thought they had found the promised land. The attacks began at the end of the 700s — pillaging, raping, stealing the treasuries of monasteries and killing, blinding or mutilating everyone who got in their way.

By 851, a Viking army…an organised army of Danes…camped on the banks of the Seine and used the river to raid far into the heart of France.

The local ‘french’ were the Palestinians then. They were chased from their lands…or, if not killed, turned into slaves or serfs of their new ‘Norman’ masters.

Once Normandy was fully under their control, the men from the North — mostly Danes and some Norwegians — built their castles, collected their ‘danegeld’ tribute…and soon began to fight with each other. They were warfighters, and thanks to a lot of practice, they were good at it.

In 1066, led by Duke William, they got together and attacked England. Now, the English were the Palestinians. After their army was defeated at Hastings, some English nobles held out. Some made peace. Some resorted to ‘terrorism’ to try to hold the Normans at bay.

But the invaders were better organised, ruthless and relentless. Land, won by the sword, remained with its new owners. The native English were dispossessed, forced to submit, die or flee. Even to this day, some of England’s green and pleasant land is still in the hands of the descendants of fierce Norman warlords.

Normans were a restless bunch. As William the Conqueror destroyed the English, a single Norman family — the Hautevilles — laid waste to much of Southern Italy. Tancred de Hauteville had 12 sons by different wives. At least one, apparently, went to England with William and ended up in Somerset. Two others, returning from the crusades, through Apulia, found their services, as swords-for-hire, much in demand. They sent for more brothers, cousins and other Norman knights. After a few decades of fierce fighting — the native Italians were the Palestinians then — they were in control of all of Southern Italy and Sicily. By a remarkable quirk of history, in 1220, one of the Hauteville descendants ended up as Holy Roman Emperor, Frederick II. He was a Hohenstaufen…but a Norman too.

Primitive Peoples

Meanwhile, England pacified, the Anglo-Normans turned their attention to Ireland. There was another prize…inhabited only by ‘primitive’ peoples.

‘Oh…the history of Ireland is as misty as the Blackwater Valley,’ says a neighbour…a fellow resident of the land along the Blackwater River.

As to both, he seems to be right. This time of year, even on a clear day, down in the valley, the mists take several hours each morning to dissipate. We live on ‘Church Hill’ — where an ancient Church tower reminds us of the clouds of Irish history. Only a few hundred yards from it are the ruins of an abbey — raided by Vikings in the 9th century…(probably) destroyed by the English in the 17th. In the other direction is a castle keep…heavy, with thick walls poking up from the morning fog. It is a relic of another part of Ireland’s history. This castle was built by the Earl of Pembroke, Richard (Strongbow) de Clare, or one of his group of Anglo-Norman invaders in the 12th century. It was fortified, protection against the native Irish and other Norman warlords.

Like Gaza in the 21st century, Ireland in the 17th century had the misfortune to be a long way from God and very close to a much more powerful and determined adversary. And like the people of Gaza, the Irish had little power…and few friends. They were seen as barbarians — poor, dirty, uncivilised. If you had been able to check their DNA back then, you would have found them very similar to the English themselves. Both were fundamentally ‘celtic,’ with a generous admixture of Viking blood. But by the 1100s, the two groups were separated by a wide gulf of history, religion, language and culture.

‘Old English’

The first Anglo-Norman invasion began in 1166. One hundred years after William the Conqueror landed on the English coast, Norman fighters, led by Strongbow, came up this same Blackwater River…the same river used by Vikings 300 years earlier. They built their castles…imposed their laws and treated the locals like…well…Palestinians.

After a few hundred years, however, these conquerors had been assimilated into the local Irish culture. They became the ‘Old English,’ who spoke Irish, married into the Irish clans, and were said to be ‘more Irish than the Irish.’

These ‘English’ clung to the area around Dublin and enacted laws designed to prevent further assimilation. The Kilkenny Statues of 1366, for example, forbade intermarriage, speaking Irish or dressing in an Irish way.

Inevitably, the more the English tried to assert their authority, the more Irish ‘terrorists’ resisted. It was a chaotic time, with battles between the English settlers and the Irish chiefs…and between opposing Irish clans, as well.

Then, in the 16th century, The Desmond Rebellions brought ‘the greatest exercise in ethnic cleansing in modern history.’

Tune in tomorrow for Part II of ‘Give War a Chance’.

Regards,

Bill Bonner,
For Fat Tail Daily