FYI | Jun 08 2016
By Peter Switzer, Switzer Super Report
Before the latest US jobs report where 38,000 positions showed up instead of the 162,000 forecasted, I was going to alert you to a view that a financials rotation might be on the way in the US stock market and invariably that would lead to good stock price news for our banks and other financials.
But the worrying employment development changes what I expected to happen and I think will delay any possible rotation. So it’s a bit like that Rachel Hunter line when it came to the regenerative powers of Pantene shampoo: “It won’t happen overnight but it will happen!”
This line is so relevant to so many aspects of this slow economic and stock market recovery since the GFC. I’d love a dollar for the number of times I have alluded to better times lie ahead and they have come, with ups and downs, but they have come.
The S&P/ASX 200 index has climbed from around the 2000-level to 5300 over an 18-year period, to keep it simple. That’s a 165% gain and if we threw in 5% for dividends, we climb over 250%. It goes higher with franking credits, so that’s my strong case for stocks, overall, even if they can disappoint like they did between April last year and February this year.
Now let’s look at why a financials rotation was being tipped and it’s so important if we want our index to one day beat the 6,000-level and then go higher. Financials are almost 40% of the index and so a comeback for this sector is crucial for the index’s growth.
Francesco Garzarelli, is the international co-head of Goldman Sachs’ Macro and Markets Research. He was reported on CNBC arguing in clients’ note that there has been little macro-investing ahead of the Brexit vote, the Federal Reserve rates decision in nine days’ time and then how China reacts to any US rate rise or not.
He says “macro investing strategies” involves investing based on expected economic policies such as a rise in interest rates, spikes in inflation or big political events.
“People know that these things are out there but they really don’t know which direction they’re going to take so the powder is being kept dry for the events realized and then we’ll see some macro direction and asset price breakout,” he said.
He thinks inflation and growth lies ahead for the world’s biggest economy and this sets up financials and small caps to benefit from rotation while the US overall stock market could remain quite flat. A development like this if it leads to rotation here as I’d expect, would be good for bank stocks here and the S&P/ASX 200 index.
Garzarelli’s note on the early 2016 stocks sell-off was instructive pointing out: “After a rough start to the year, when fear of a slowdown in global growth and lower commodity prices took its toll on market expectations of future price increases, U.S. ‘break-even’ inflation has staged an impressive comeback.”
Remember in a world fearing deflation, inflation is seen as a good thing telling us that the US economy is on track to something more like a normal economy.
So growth, inflation and an economy on the comeback trail is good for financials and that’s why I have been delighted our recent economic performance and how it should help bank share prices going forward.
On top of that there is an international connection between banks and their share prices. Earlier this year question marks were raised over Deutsche Bank and its share price plummeted 32% before it backed itself buying 5 billion euros worth of its bonds back. That was February 12 and coincided with the turnaround of global stock markets. It was a supportive development that with the spikes in oil and iron ore prices help to explain the stock market surge from that time.
Bank stocks worldwide had tumbled when European bank stress tests were rumoured to be worryingly bad but reality was often better than the speculation and bank stock prices then rebounded.
So my thinking is if the US banks start to pick up, it will give our banks a fillip and it could easily coincide with continued good economic growth numbers which we’ve seen over the December and March quarters. Growth in the 3%-band should underpin better economy-wide profits, wage growth and better times for bank bottom lines.
This is all and good but what if that May jobs number in the USA over the weekend says the Yanks’ economic recovery is teetering? If that’s right, then all bets are off for my banks rotation story, however, I reckon the number is a rogue one.
History has shown, provided the USA is not in recession, that a really shock, horror, surprise jobs number is often followed up by a big compensatory result in the following month. And by the way, 35,000 Verizon workers on strike hurt these numbers too, so I’m prepared to bet, given the overall run of US economic data that this job number can’t be trusted.
That said we now have to wait for the Fed meeting on June 15, the Brexit vote on June 23, and then next jobs report in a month’s time. All of this adds negativity to that pesky month of June, which is not great for stocks.
However, if the job numbers do bounce back we could be set up for a bank stock revival. The Financial Times explained the banks’ connections to economic expectations this way:
“This year, US banks have traded as if as a proxy for year-end rate expectations. They fell sharply as scepticism grew that the Fed would follow through with all the 2016 rate rises suggested by its ”dot plot” of official projections. The sell-off reached a peak in February when markets implied there may be no rate rises at all this year, and long-term rates fell with the darkening outlook for the global economy.”
The FT analysis concluded: “Low rates narrow the available margin between banks’ cost of borrowing and the interest they can charge on lending.” So better economic times with inflation and higher interest rates are good for banks.
So if you are yearning for better bank share prices then yearn for better economic growth outcomes and hope, like me, that this May jobs number in the USA was an outlier and that the US recovery is on track.
If that works out then my banks’ share prices comeback should happen. Of course, I think it will happen but it might not be overnight.
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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