Why this good news is bad for stocks
Monday, 5 February 2018
By Bernd Struben
- Wasn’t that good news?
- No worries for property investors
- In the mailbag
In last Monday’s Port Phillip Insider, I recommended you hold off shorting US markets.
While I believed a correction of 10–15% was overdue — and still do — I didn’t expect that to happen just yet.
Today it looks like I may have to eat those words.
Following Friday’s trouncing, the Dow Jones Industrial Average is down 4.0% over the past week. Meaning a simple inverse equity ETF (Exchange-Traded Fund) could have seen you gain about 4% in one week.
The ProShares Short Dow30 ETF, for example, aims to deliver the inverse daily performance of the Dow Jones. If the Dow falls 2%, the ETF rises the same amount.
For larger potential gains — and larger losses — the ProShares UltraPro Short Dow30 corresponds to three times the inverse of the Dow’s daily returns (minus fees).
If the Dow gains, though, you will lose three times the amount of any rise. Always tread carefully when using leverage. And never invest more than you can afford to lose.
But on Friday those betting against the Dow had cause to celebrate. And the leveraged ProShares UltraPro Short Dow30 ETF gained 7.79% in one day.
That gain comes thanks to Friday’s 666-point fall in the Dow. That’s the index’s biggest single day loss since December 2008. A time that veteran investors will recall all too well. And none too fondly.
In percentage terms the fall isn’t quite as drastic. You have to take into account that the Dow is coming off all-time highs over 26,000 points. That puts Friday’s loss at 2.54%, making it the biggest fall in ‘only’ 20 months.
The other major indices in the US and Europe also closed well into the red over the weekend Aussie time. And as at writing Asian and Aussie markets are following suit.
Let’s have a look at those now…
Over the weekend, the Dow Jones Industrial Average closed down 666.75 points, or 2.54%.
The S&P 500 lost 59.95 points, or 2.12%.
In Europe, the Euro Stoxx 50 index finished down 54.07 points, or 1.51%. Meanwhile, the FTSE 100 fell 0.63%, and Germany’s DAX lost 218.74 points, or 1.68%.
In Asian markets, Japan’s Nikkei 225 is down 560.15 points, or 2.41%. China’s CSI 300 is down 0.73%.
In Australia, the S&P/ASX 200 is down 95.09 points, or 1.55%.
On the commodities markets, West Texas Intermediate crude oil is US$64.99 per barrel. Brent crude is US$68.11 per barrel.
Gold is trading for US$1,332.77 (AU$1,685.56) per troy ounce. Silver is US$16.64 (AU$21.05) per troy ounce.
One bitcoin is worth US$8,242.44.
The Aussie dollar is worth 79.07 US cents.
Wasn’t that good news?
So why the sell-off in stocks?
The mainstream financial pages are crammed with various theories. So I’ll keep it brief here.
For much of the past five years, stock markets have gone up with poor economic news. Especially when this news relates to the US, the world’s biggest economy. Though poor economic news out of the EU, China, and here in Australia has often seen similar reactions from ASX listed stocks.
It’s the old ‘bad news is good news’ phenomenon.
When reports show wages falling and unemployment on the rise, investors can count on central banks stepping in. Interest rates go down, or at least not up. Central banks print more money. And stocks generally rise.
(Simplified, I know. But I did promise to be brief.)
Now the US economy is looking stronger. At least that’s what the official data is claiming. Unemployment in the US is close to what’s considered ‘full employment’. Wages are showing signs of growth. And inflation is stirring from the dead.
That’s good news. And it means the US Fed is likely to push ahead with three interest rate rises this year. It’s also likely to continue quantitative tightening (QT). That’s the opposite of quantitative easing (QE), where the Fed purchases US government bonds.
But all this talk of inflation and higher interest rates is giving bond investors the jitters.
The yield (interest) on the 10-year Treasury bond is up more than 0.4% this calendar year, putting it at a four year high. The yield now stands at 2.84%. And it may well head higher.
As a quick review, bond yields move opposite to their price on the secondary market. And prices on the secondary market have been coming down.
Now you can always hold a bond to maturity and get its full value back. But let’s say you’re holding a 10-year bond paying less than 3% and inflation overshoots the government’s target of 2–3%. Let’s say inflation hits 6% instead.
You can see how you might take a capital loss on the bond’s purchase price to get out of losing 3% per year for the next decade.
Meanwhile, with the return from bonds going up as their prices fall, bonds begin to look relatively more attractive compared to stocks.
Have a look at the chart below. It shows the returns investors have been getting in the stock market (S&P 500) compared to bonds (US Treasury total return index) is at a record high.
It’s also worth noting the two previous spikes, and recalling what happened to stock prices at the time.
Click to enlarge
If interest rates continue to rise, bonds begin to look more appealing to stock investors. Bonds are generally considered lower risk, and it’s no secret that stock valuations are already stretched.
So, is it time to short the markets?
Perhaps. Though last Monday would have been better!
But these types of corrections do tend to have some momentum. Especially if we get any more good news on the economic front.
No worries for property investors
But what does all this mean for Aussie property prices? Prices in Sydney are already in decline. And price growth in Melbourne has slowed dramatically.
If stock markets take a beating, you’d think property prices might tumble as well.
Not so, assures our intrepid Treasurer, Scott Morrison.
From The Australian Financial Review:
‘Financial regulators may dial back home lending restrictions which have helped clamp down on rampant property price growth, if the recent slowdown in property values descends into sharper-than-anticipated falls, the federal Treasurer has signalled.
‘The government was “closely watching” the cooling residential real estate market Scott Morrison said.
‘Tighter home lending measures imposed on banks over the past year were “completely malleable”…’
Well that’s a relief. We wouldn’t want to lose our coveted rankings among the top 10 most expensive cities in the world.
In the mailbag
In Thursday’s Port Phillip Insider, I offered my top takeaways from Donald Trump’s State of the Union address.
I also mentioned that, in my most humble opinion, Trump and many Americans are hampered by their obsession with their flag, their anthem, and God. Writing:
‘The point here isn’t that you should run out and burn someone’s flag. Or belittle their deity. Or disrespect their anthem.
‘The point is that all three of these are merely symbols. A song. A piece of cloth. An imagined super being.
‘In idolising these symbols, Americans open themselves up to all kinds of unnecessary provocation.’
Some readers wrote in to say that in using the term ‘imagined super being’, I had indeed belittled their deity. And they felt duly provoked. I’ll share three of those with you today.
First this mail from Cherie:
‘As a born again Christian I strongly disagree with your email. To me God is not an imagined super being, He is alive and as powerful as ever. As for putting my trust in family, friends and countrymen, they would be the last that I would put my trust in as it is human nature to disappoint and betray. God alone is the only one to be trusted and the only one who does not disappoint. Far better to put your faith in the God who is still in ultimate control of this world whether you wish to acknowledge it or not. This world is only going from bad to worse because people like you have turned their backs on the God who loves them. You will never know perfect joy, peace and contentment unless you know God’s Son. Unless you have a relationship with the Supreme Creator, you will never see the miracles and know that Almighty God is still in control. God will honour those who honour Him!’
Then there was this from Peter:
‘It would be a good idea if Struben were to leave his outrageous reference to God back in Holland, along with himself. We don’t need that garbage in Australia.
‘Tell him to stick to something he’s convinced in his own mind that he knows something about.’
Good Lord, man, do you know what the weather is like in Holland this time of year? I’ll pass thanks.
Finally, there was this from Barry:
‘I write to you regarding some comments in PPI today (Thurs 1 Feb)
‘You write “The point …..isn’t ….to belittle their deity.. .The point is all these are symbols ….An imagined super being ..”.
‘I agree with your first statement, but not your statement inferring God is an “imagined super being” and the deeper inference that He is not to worshipped. I agree with you that “idolising” a flag, or a song (or a football team or a popstar) is bound to lead to disappointment. Belief (and faith) in God can be neither proven nor disproven (despite Richard Dawkins fundamentalist beliefs!). Given the statistics on the perpetrators of family violence (cf Rosie Batty), and the behaviour of men in the 1990s Balkan wars, I’m not sure faith in family, friends and countrymen is any more useful than faith in any human social structure (including cryptocurrency!!).
‘Without wishing to “convert” you, my study of world history leads me to the conclusion that human social history is most clearly understood from a Christian perspective. Regarding the existence of God, my experiences are not imagined –they are real. Because you have not had my experiences, you cannot describe my experiences as “imagined”. From your comments, I infer you are an atheist – I respect your belief –but I hold a different worldview and come to different conclusions. I know what will happen to me when I die – I do not claim to know what happens to others.
‘In some sense, there is a parallel with the panel of writers / analysts you have at PPP. They look at the same evidence, but come to different conclusions and make different recommendations (e.g. Vern Gowdie vs almost everyone else!) This is one of the reasons I find the PPP subscriptions so valuable; your analysts can come up with conflicting interpretations of the same evidence and I am challenged to think seriously about what I am going to do with my (very small) investment funds.
‘Thanks for all the effort you and the PPP team make in providing subscribers with a critical analysis of the markets and (most often) well thought out reasons for conclusions. I hope you have a successful 2018.’
Thanks to everyone for writing in.
Our beat here isn’t religion…or lack thereof. It’s helping readers make money. In up markets, down markets, and sideways markets, our editors always have new ideas on how to do just that. And whenever I can, I’ll share those ideas with you here.
If you have any comments on today’s edition, or anything else, email us at email@example.com. If we publish your letter we’ll only use your first name.
Finally, while we’re on the topic of politically incorrect and sensitive subjects, check out the following…
In today’s Australian Tribune: ‘Victoria’s Firearms Amendment Targets Innocent Bystanders’
‘There’s a particular part of Victoria’s proposed Firearms Amendment Bill 2017 that should concern you.
‘Regardless of how you feel about guns.
‘The Victorian government is logically concerned about increased gun violence in the state. But they’re approaching the problem waving a big stick. As you’d expect from the government…’
If you’re fed up with reading sanitised, politically correct dogma cut and pasted from one mainstream source to another then The Australian Tribune is for you.
And it’s absolutely free.
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You can visit our website at https://www.theaustraliantribune.com.au/ to read the complete article above now.