Rudi's View | May 23 2018
In this week's Weekly Insights:
-Crude Oil, The One To Watch
-FIIG High Yield Conference: Get Ready
-Housing Finance Growth, The Australian Canary?
-CSL, Sign O' The Times
-Rudi On TV
-Rudi On Tour
-At The AIA Conference
[Note the non-highlighted items appear in part two on the website on Thursday]
Crude Oil, The One To Watch
By Rudi Filapek-Vandyck, Editor FNArena
There are probably as many similarities with the situation in 2008 as there are differences back then with global energy markets today, but one key characteristic hasn't changed: energy producers are one of the best performing sectors on the stock exchange and many an enthusiastic market follower is looking upwards for more investment gain potential.
Can we really see Brent crude oil futures revisit US$100/bbl this year?
If so, the answer may not lay with Saudi Arabia and OPEC, but more likely with Venezuela, or Iran (Trump permitting), while the US shale industry sorts out its infrastructure bottlenecks. Equally important, if we do get to see further upside in global oil prices, at what point does this start to weigh upon market sentiment?
One historic correlation the world temporarily forgot about back in 2008 (despite me reminding everyone who cared to listen), is that higher priced oil does come with consequences for everyone outside the oil industry. Even mining companies experience a spike in their bills for diesel to keep those big Tonka trucks on the road and moving dirt.
One popular saying is that higher priced oil is effectively a higher tax on the broader economy with both households and businesses forced to pay up. No wonder thus, a significant rise in the price of energy is what has caused economic recessions in the past, including in 2008 (even though that correlation is seldom highlighted).
Usually, the rule of thumb is that the price doubles in less than a year, after which an economic recession becomes the logical consequence. As with interest rates and bond yields; gradual rises are OK, rapid spikes not because they don't leave enough time for the world to prepare and to adapt.
So what's the situation right now? If we focus on the US$30/bbl bottom reached in February 2016, the price of oil has now more than doubled in around two years. But one has to take into account that for most of the period crude oil futures have been trading inside the US$50-60/bbl zone, so while today's US$70+ prices represent an extra burden for the global economy, it's not quite the same as the price rallying all the way to US$147/bbl ten years ago.
If we do get back above US$90/bbl and the market sets its sight upon three digits again, that will be the time to really start worrying. In the meantime, I have spotted the first few economists who now believe the brakes are on for global economic growth, because the twelve months gain is about 40% and one has to admit, the odds still seem in favour of higher oil prices.
Morgan Stanley, too, uses strong gains for energy prices as an important input for its relatively benign outlook for risk assets in the year ahead. The chart below reminds everyone energy is a "classic late cycle performer".
The implication here is twofold: on one hand there could be a lot more outperformance on the horizon for Woodside Petroleum ((WPL)), Origin Energy ((ORG)), Oil Search ((OSH)), Beach Energy ((BPT)), and the likes; on a secondary level it also functions as the proverbial canary telling us this cycle might be in its final innings.
On Monday, oil price forecasters at Commonwealth Bank significantly raised their price estimates for the next 24 months, arguing problems and supply restraints in Venezuela and elsewhere are likely to keep an upward bias on global oil prices while demand in the short term will exert inelasticity. The latter means demand won't be negatively impacted in the short term.
CommBank's new oil price forecasts are for Brent to average US$79/bbl in 2018, and then US$86/bbl in 2019. Given these are averages, all of a sudden US$100/bbl doesn't seem out of the question.
Also, with Saudi Arabia's focus on IPO-ing 5% of the world's largest oil producer, Aramco, the forecasters believe the Kingdom of Saud will be more focused on its own shorter term interest, than on further out impact for the rest of the world. Better buckle up!
FIIG High Yield Conference: Get Ready
"The US economy will be in recession by late 2019, or in 2020. If we all come back here in two years' time, I'll be amazed if the US is not battling the next economic recession."
Visit an equities investing conference and visitors have to endure a portion of BS plus a whole lot of marketing, said one of the attendees at last week's High Yield Conference organised by FIIG in Sydney. But visit a conference with lots of experts from fixed income markets and one is guaranteed to hear multiple cautionary statements, I was quick to add.
Quod erat demonstrandum.
Not everyone on the panels, or on stage, wholeheartedly agreed with the forecast made by Head of Australian Fixed Income at Aberdeen Standard Investments, Nick Bishop, but the general sense was nevertheless that things are starting to look a little less robust around the world, while US inflation is lifting its head, the Federal Reserve is intent on further normalising rates and shrinking its balance sheet, and asset prices, from equities, to high yield bonds, to properties and others, are richly priced.
At some stage there will be wobbles, or worse.
Time to switch portfolios and strategies into defensive mode again. Or as one of the expert panel members put it: instead of focusing on further gains that can possibly be still had, investors should now start zooming in on what can go wrong, and the potential consequences for their portfolio of assets.
The US bond market seems to be heading for a point of reflection whereby the 10 year bond yields fall below the 2 year. Already, the 30 year bond in the US yields less than the 10 year and the gap between 2 and 10 has been shrinking for a while now. At the current pace, yield inversion might occur by early next year, which would -all else remaining equal- put financial markets on notice because an inverted yield curve is often (not always) a harbinger of economic recession, which feeds into the prediction at the start of this report.
In Australia, one probably shouldn't expect anything from the RBA. No inflation. No wage growth. Consumer spending tepid. House prices are now trending downwards. Australian banks are effectively tightening (thus the RBA won't). Were that prediction about US yield inversion and the subsequent US recession to materialise, there is a fair chance governor Philip Lowe might end up eating his own words about the next move in the RBA cash rate likely to be up.
Also, Australian bonds traditionally offer a premium versus US bonds, but that premium has recently turned into a small discount. With the Federal Reserve continuing to hike, and the RBA firmly on hold, one should expect the current discount to widen into what shall become a negative, all-time wide, never-before-witnessed gap between 10 year government bonds in Australia and in the USA.
Irrespective of what goes on in the world of bulk commodities and energy, this will eventually exert a heavy downward pressure on the Australian dollar, one presumes.
Finally, those worried about negative consequences from Quantitative Tightening (or the end of Quantitative Easing, or the Fed shrinking the balance sheet) should maybe focus on high yield bonds instead of fearing Armageddon for government bonds in general. Central bank policies forcing investors higher up the risk ladder has meant that traditional funds flows have switched in years past from risk free government bonds to higher yielding fixed income markets. With the yield differential between the two near all-time lows, and government bond yields rising, fixed income markets are approaching the point whereby money starts flowing into the opposite direction again.
Bottom line: the Federal Reserve's absence as prominent buyer of US government bonds does not imply there won't be any buyers left for US treasuries.
On Monday the team of economists at National Australia Bank became the latest to push out anticipated timing for the next RBA rate hike to mid-2019. There is now quite a large contingent of all sorts of forecasters and market "experts" who'd rather not be reminded they had been quick, and vocal, in 2017 about imminent rate hikes in Australia.
Ah, but happiness is nothing more than good health and a bad memory (German theologian Albert Schweitzer).
We have added 2x more instalments of The Unfair Advantage.
One on yield investing in the Australian share market and one on Premium Quality, High PE stocks, and whether they are due for a fall:
Both videos can also be accessed directly through the website. See FNArena Talks, The Unfair Advantage.
Rudi On TV
This week my appearances on the Sky Business channel are scheduled as follows:
-Tuesday, 11am Skype-link to discuss broker calls
-Thursday, from midday until 2pm
-Friday, 11am, Skype-link to discuss broker calls
Rudi On Tour
-Presentations to ASA members and guests Gold Coast and Brisbane (2x), on 12 & 13 June
-ATAA members presentation Newcastle, 14 July
-AIA National Conference, Gold Coast QLD, June 29-August 1
-ASA Presentation Canberra, 3 August
-Presentation to ASA members and guests Wollongong, on September 11
-Presentation to AIA members and guests Chatswood, on October 10
At the AIA Conference
As stated in the overview above, I will be presenting at the AIA National Annual Conference at the Marriott Resort and Spa Surfers Paradise, from 29th July til 1st August 2018.
This year's theme is SYNCHRONICITY, Identifying opportunities in a world growing in sync…
For the first time in over a decade, the world’s major economies are growing in sync.
What does a world that is structurally awash in capital look like?
What will it mean for investors?
(This story was written on Monday 21st May. Part One was published on the day in the form of an email to paying subscribers at FNArena, and again on Wednesday as a story on the website. Part Two will be published on Thursday).
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