FYI | Jul 12 2017
By Peter Switzer, Switzer Super Report
Rates to rise 8 times! Good or bad for stocks?
Former RBA director and former banking chief economist, John Edwards, reportedly said interest rates could rise eight times in two years. This has spread fear into the hearts and wallets of those over-borrowed types with home loans but retirees, who love the security of term deposits, would have to be icing up the champagne bottles for 2019!
The best one-year term rate in Australia right now is 2.75% at Bank Australia, and, if we saw the cash rate rise by 2% in two years, a rate of 4.75% could start attracting money out of the stock market. It could be a precursor to a big market shake out but it would imply that for the next two years, the stock market could go gangbusters.
But how realistic is this?
In recent weeks, the bond market, which some argue borders on infallibility (I’m not one of them), has been putting up yields. This has sparked a bit of negative volatility on stock markets but I’d argue this is the reaction of short-term players, who need to rejig their investment/trading plays.
For the long-term investor, the higher yields are actually saying: “We, the bond market experts, got it wrong earlier this year when we started buying bonds, driving up bond prices and sending yields lower”.
The bond market was too negative on the economic outlook then, and now it might be becoming too positive. Whatever the real story, at least I think they’re getting it right now.
The link between the bond market and the stock market often gets clouded when you see the likes of Bloomberg run with a headline such as: “Bond Market's Positive Vibes Suddenly Disappear.”
This is saying that the demand for bonds is set to fall so bond prices drop and yields go up, but the question you have to ask is: why?
The two big reasons that the markets have concentrated on have been that central banks will be raising interest rates and they’ll be selling bonds after a near decade of buying the suckers to rescue the world economy from recession.
What gets lost in this bond market drama is the fact that the world economy is getting stronger. Over the weekend, we saw the US economy created 222,000 jobs in June, when only 179,000 was expected.
And this from Bloomberg emphasises my point: “After months of disappointing economic data, growth trends look more positive. The Federal Reserve Bank of Atlanta’s GDPNow index puts second-quarter GDP at a solid 2.7%, and third-quarter estimates are in the same neighbourhood. Those kinds of numbers would give the Fed a clear path to hike in December, even though the market has roughly 68% of such a move priced in as of Wednesday.”
This can’t be bad news for stocks, which interests me more than the bond market.
A CNBC headline such as this: “The Party is over: central banks pull the plug on bond market” could worry some investors but again the focus is on the bond market.
Sure, easy interest rate policies also helped stocks and if the global economic outlook wasn’t on the improve, I’d be worried. But it is. This chart showing how well Purchasing Managers’ Indices are doing proves my point:
Also, this chart showing the EPSs of global stock markets are also heading up in a synchronized way for the first time since 2010 has to be a plus for stocks.
This is an important piece of evidence suggesting that the stock market’s bull run still has some upside and European interest rates going from negative to just positive shouldn’t have an immediate impact on this bullishness. Either should US rates only sneaking up in a measured way.
Source: Citi Research, Factset
I know there are some curve balls out there that could make the stock market strike out in the short term but it would more than likely be a buying opportunity.
Remember, this good economic news is happening without much help from President Donald Trump’s tax policies but if they get up, say in 2018 ahead of the mid-term elections late in the year, then the positive market momentum would be guaranteed.
On Australia, and eight interest rate rises in two years? I doubt it. If this happens, then our economy would be growing close to 4%, inflation would be rising, wages would be spiking much faster than now and stocks would’ve had two good years.
Then I could be seriously thinking of taking profits and waiting to see how high rates would go but this is a highly speculative scenario.
For the time being, I remain positive on stocks while being wary of another sell off, after which I’d be a happy buyer. That said, given the good run of economic data, maybe the sell off has already happened.
This is my preferred position.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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