Australian stocks rose 1.45% in February, underperforming the 1.85% rise in the US. Large caps again led the market higher again, with the ASX 20 up 2.5%, compared to a 1.4% rise in the Small Ordinaries. The rotation continued from growth (mainly tech) to value (mainly financials) with value outperforming growth by 9.4% in February. Value has now outperformed growth for 5 months in a row, with total outperformance of +31%.
All eyes in our world are watching bond yields at the moment as central banks are now skating on thin ice as to how they react and to what extent their reaction will impact markets. The recent RBA meeting reaffirmed the 10-basis point target for the cash rate and 3yr government bond. The RBA noted that it’s committed to keeping monetary conditions favourable until inflation and labor markets reach desired levels by the RBA which isn’t expected before 2024. In a show of their commitment, the RBA surprised all with an unexpected 3 billion bond purchase followed by a further 4 billion a few days later to halt rising bond yields.
Rising yields? So what?
Yields are rising as investors are selling bonds due to greater optimism about the economic outlook. Yields are steepening at the long end of the curve faster than the yields on the short end, in other words, the market is pricing in higher longer term inflation expectations.
For investors, the question becomes: what are the implications for risk assets? Will equities continue rallying on ample liquidity? Or will they capitulate to the impact of a higher discount rate?
The answer depends on the duration of the assets. Longer duration stocks, such as growth stocks (eg tech and healthcare sectors), are more sensitive to the discount rate. This is especially true when valuations are elevated, as they are today. Meanwhile, short duration sectors with higher dividend yields are less vulnerable. This is especially the case for financials, which benefit from a steepening yield curve.
In December I mentioned the correlation between the Aussie dollar and commodity prices and how strong commodity prices will coincide with a stronger AUD, vice versa. Since then we have seen the AUD hit 0.80c and commodity prices continue to surge higher. Macro conditions still provide steam for commodities to keep the surge going, Supply-side disruptions, relentless weaker US dollar and continued Chinese demand. However a strong AUD is not favourable to the RBA, so it’s expected they will take action to stop the increase in the AUD i.e. print money. This shouldn’t impact commodity prices even with the correlation thesis.
Oil once again remains bullish as the markets supply fundamentals are unchanged from last month. Supply continues to be cut from Saudi Arabia. The outlook for oil should however remain cautious as Saudi-Russian tensions may arise with oil above $60/bbl.
Over in the US, the Texas energy crisis left millions of Texans without power in freezing weather conditions. The unprecedented polar vortex split, dumping Arctic air down to the Gulf of Mexico, resulted in frozen wellheads that impeded the flow of natural gas to power stations, triggering electric shortages as demand overwhelmed the grid. Although this only affected a relatively small number of Americas and the world’s population, it was a warning and wake up call for all, highlighting our dependence on energy and how important the functionality of our energy grids are and the turmoil than can pursue if such fails.
Gold continues to remain out of fashion since its all-time high above $2,000 US, subsequently, gold miners have been left behind, down around 35% since its early August high. Gold topped as yields bottomed. So as yields continue to climb gold should continue to fall. But with Central bank intervention targeting yields and trying to halt there increase there is potential that if yields top it could call the near-term bottom for gold. With inflation likely to run hot into year end, gold should see upside as its typical hedge against inflation thesis. But at the moment Gold is not showing any signs of turning the trend around
Below shows the inverse correlation between yields and gold. *note* yield is inverted to show the correlation.
As for the Australian property ‘bubble’, low interest rates, improving economic conditions, and a supply shortage are fueling continued increases in house prices. The NAHB (National Association of Home Builders) Housing index crept up 1 point month-on-month to 84 in February, beating market expectations for a print of 83 slightly, despite rising costs in the industry. NAHB chief economist Robert Dietz said: “Demand conditions remain solid due to demographics, low mortgage rates and the suburban shift to lower cost markets, but we expect to see some cooling in growth rates for residential construction in 2021 due to cost factors, supply chain issues and regulatory risks.”
Last month I also mention how financials had been quiet and had underperformed for several years. I said that four potential factors could provide juice for the sector and bring it back into fashion. Second, behind materials on the catwalk for February was none other than Financials returning 5.1% for the month. This highlights not only the rotation into value but also institutions rebalancing, with most previously underweight in financials especially the banks with some standout performers, ANZ +12.5%, WBC +14% and BOQ +13.3%.
All the best.
