Trump in the Box Seat. RBA Has the Seat Out of Its Pants

Wednesday, 4 November 2020
Wollongong, Australia
By Greg Canavan

[5 min read]

At time of writing, the outcome of the US election is not yet known. And we might not know it for a while yet.

Trump is looking good though. The TAB now has him at $1.33 favourite. No! $1.28 favourite and getting shorter all the time. Biden is blowing out and is a $3.75 outsider.

If Trump does get up, look for the market to unwind the bets it made over the past few days.

While we watch and wait, just remember this:

From an economic, big picture perspective, the outcome of the election doesn’t really matter. The US is in a debt trap. The Federal Reserve is out of ammunition. Now it will come down to massive fiscal deficits to try and dig the US economy out of the hole. But policy makers don’t realise they’re just digging deeper.

Australia has the same inept policymakers. We’re just a few years behind.

Yesterday, the RBA announced a cut in the cash rate to 0.1%. It’s also targeting a 0.1% rate for both three-year bonds and money accessed by the banks under the Term Funding Facility. So far, the banks have drawn on $83 billion from this facility, and have access to a further $104 billion.

In addition, the RBA will start its own quantitative easing (QE) program, with a commitment to buy $100 billion in government bonds over the next six months.

This all sounds great, doesn’t it?

Well, it does for maybe a few seconds.

But then, when you stop to consider that QE hasn’t worked anywhere else in the world, you realise it’s not going to work in Australia either.

The RBA surely know this. But when everyone else is doing it, well, you just have to join in, don’t you? And in doing so, you have to believe what you’re doing makes a difference. At least publicly. Here’s what the RBA boss Philip Lowe said in his statement yesterday:

Together, these three elements represent a significant package. The lower interest rates and our plan to buy $100 billion of government bonds over the next six months will help people get jobs and support the recovery of the Australian economy.

The package combines the price-based target at the shorter part of the yield curve that has been in place since March with a quantity target at the longer part of the yield curve. In doing so, it will lower the whole structure of interest rates in Australia. This lower structure of interest rates will work to support the economy through the normal transmission mechanisms, including lower borrowing costs, a lower exchange rate than otherwise and higher asset prices.

Since peaking in 2011 at 4.75%, the cash rate has inexorably declined. Has it provided any long-term benefit to the economy? Of course not. The economy is in worse shape now that it’s been in years.

You can tell the RBA is worried. That’s why they attached a speech from Lowe to the announcement, answering questions such as ‘With interest rates so low, is the RBA now out of fire power?’ Of course not, they say…which is as good as saying, ‘yes they are’.

Needless to say, I don’t think these latest measures will have much of an impact either. The cost of credit isn’t really the issue in the economy. The demand for funds, and the opportunity to invest and generate a decent risk-adjusted rate of return, is the real problem. Simply increasing supply won’t change that.

It’s also worth pointing out that the RBA took these measures to weaken the currency. While I think that will happen eventually, it certainly hasn’t had the short-term impact the RBA would have hoped. The Aussie dollar rallied strongly overnight!

I asked a few of the analysts here what they thought of the announcement and how it might impact the areas of the market they focus on closely.

Ryan Dinse, editor or Exponential Stock Investor, Small-Cap Momentum Alert and Extreme Crypto Trader said:

The boring answer is that it will probably help keep the speculative mania party going which will be good for small caps for a while yet.

On the trading front, I’ll be looking for breakouts in sectors that are attracting money flow. On the investment front, it’ll be all about looking for companies making a mark in disruptive, high growth industries.

On a side note, my bank unbundling thesis from 2019 will also get yet another boost from this as lower interest rates are bad for big bank profit margins, and adds to their current woes.

The deeper answer is that it’s yet another sign of the ongoing destruction of fiat money as a store of wealth.

This of course help propel forward the idea of alternative “reserve assets” like bitcoin and gold. After all, a big part of the appeal of “money in the bank” is earning interest. Which is now non-existent.

And on measures of “scarcity” and “censorship resistance” bitcoin wins hands down.

Lachy Tierney, who co-edits Exponential Stock Investor with Ryan, said:

Small-caps to continue chugging along is my bet.

Particularly resource small-caps.

If the RBA is going to race to the bottom in the currency devaluation wars, then this could play into the hands of miners.

Also, it’s interesting to see LYC up and about in the charts.

I’d be looking beyond iron ore and more at tech metals.

Callum Newman, editor of Catalyst Trader, is a little more cautious:

I’m seeing a degree of caution across the small cap space currently. The US election could be responsible for this, or not. It’s hard to say. I don’t necessarily see QE as automatically bullish for stocks. The counterpoint is Australia’s savings rate is very high and credit growth is modest at best. However, pinning down rates in such a manner does mean lower borrowing costs and will further bias Aussie banks to issue mortgages. Hence, I expect QE to inflate housing more than the stock market.

Ryan Clarkson-Ledward, editor of Australian Small-Cap Investigator, says gauging the impact of local QE operations is the ‘million-dollar question’:

Compared to the Fed’s apparent US$6.56 trillion balance sheet of US bonds and mortgage-backed securities, the RBA’s $100 billion intervention seems almost trivial. But, the difference in size between our two economies is a critical factor too. 

For these reasons it is hard to gauge whether we’ll see a NASDAQ-like bull run or simply a slight uptick. After all, the S&P 200 has been stubbornly flat since its mid-year recovery. Perhaps QE will finally be the catalyst to kick large cap returns back into gear.

Personally though, I’m not all that interested in how the blue chips will respond to QE. As a small-cap enthusiast and analyst, my interest is instead focussed on how the tail end of the market will respond. After all, small-caps have already been running hot since the March lows. So, rationally, I would expect the market to be wary of bidding-up already pricey stocks. But again, if the US markets are any metric, there is nothing rational about QE. Because of that we could see some of the high-flyers soaring to even higher heights.

More importantly, I think small-cap investors should now be watching the Aussie dollar closely. Because as Philip Lowe has made clear, his intention is to push the value of the dollar down — making it more favourable for Aussie exporters.

Because of this, I am personally looking closely at the small-cap mining sector. Especially any established miners with sales overseas. This is because most commodities are generally traded in US dollars, meaning that a weaker AUD will net them more local currency when converted from the US dollars. Or in simple terms: more revenue / profit simply because of currency conversion.

So, my QE takeaway is to keep an eye on small-cap exporters.

And finally, co-editor of New Energy Investor, Selva Freigedo, reckons cheaper debt will only support increased investment in the transition to new energy:

Lowering the cost of money plays into the transition from fossil fuels to a low carbon economy. Governments are preparing stimulus packages that include renewable energy to create jobs and decrease energy dependence from other countries. Cheap debt only helps this.

My fellow editors are an optimistic bunch. They largely see it benefitting the parts of the market they focus on.

I’m not so sure. I don’t think it will do too much at all.

For that, you’ll need the rest of the world to help drag us along.

And I’m even less confident of that happening!

Oh, one more thing. Remember the algo signal Woody and I have been discussing the past few weeks? It’s still telling you to stay in cash. Unlike the market over the past 48 hours, it didn’t buy the ‘Blue Wave’ thesis. It’s much too smart for that.

Woody will have another update for you on Friday.