Which Stocks Are the Winners in This Mini-Crisis?

Close-up Of Business Graph
Reddit

Finally, some unequivocal bad news for the US economy. On Friday, the US Department of Labor reported that the US economy added just 142,000 jobs for the month of September, much lower than the 201,000 expected.

Wall Street plunged on the news. At one point, the Dow was down 258 points. But in an instant, the punters remembered that bad news for the economy was good news for the stock market. Stocks quickly rallied. The Dow finished up 1.23% and the S&P500 was up 1.43% on the day.

Bring back the bad news!

Keep in mind though the rally was predominately lead by the commodity sector. Bad news on the economy means less chance of an imminent interest rate rise which means relief for interest rate sensitive sectors like commodities.

Given the hammering taken by the commodity sector in recent weeks, I would argue that Friday’s rally was merely driven by short covering. This occurs when traders reverse previously made bearish bets, pushing stock prices momentarily higher.

But the main trend is still down across the broad commodity sector. You need to see at least a few months of constructive price action before you can be confident that the worst is over.

The Fed holding off on interest rate rises will help. But it won’t be enough. If the Fed doesn’t raise rates soon it will be because the US economy is weaker than nearly everyone thought.

And despite Friday’s stock market rally, some sectors weren’t happy with the lower interest rates for longer mantra. From Bloomberg:

Bank stocks declined as the U.S. jobs report fell short of forecasts and bond traders pushed back expectations for a Federal Reserve rate hike until next year.

Higher interest rates will allow banks to earn larger spreads on the deposits they’ve collected. While the Fed’s efforts to reduce rates stabilized asset prices and helped lenders access cheap debt in the wake of the credit crisis, prolonged low rates have crimped banks’ margins.

Ahhh, the banks! For years they enjoyed the benefits of lower interest rates. It helped preserve the overinflated value of the assets on their balance sheets. But now that phase is over, they want higher rates to squeeze more profit margin out of savers.

This is also a sign that prolonged low interest rates do long term damage to the financial system and economy. Low interest rates suck the profitability out of the financial sector and encourage excessive risk taking. This has been going on for years. You’re now seeing increasing volatility and uncertainty as a result.

Jim Grant, from Grant’s Interest Rate Observer, hit the nail on the head in a recent interview:

The mispricing of biotech stocks or corn and soybeans is of no great consequence to financial markets at large. Interest rates are another matter. They are universal prices: They discount future cash flows, calibrate risks and define investment hurdle rates. So interest rates are the traffic signals of a market based economy. Ordinarily, some are amber, some are red and some are green. But since 2008 they have mainly been green.

Grant means it’s been a green light for excessive risk taking. But at some point such risk-taking does untold damage to the financial system. The foundation becomes incredibly weak. At this point, only faith in central bankers holds the apparatus together. More from Grant:

This is a monetary moment. I think we are looking at the beginning of the world’s reappraisal of the words and deeds of central bankers like Janet Yellen and Mario Draghi. What we’re waiting for is a sufficient recognition of the monetary disorder. You see monetary disorder manifested in super low interest rates, in the mispricing of credit broadly and you see it in the escalation of radical monetary nostrums that are floating out of the various central banks and established temples of thought: Negative real rates, negative nominal rates and the idea of helicopter money. So you need some hedge against things not going according to the script and that makes gold and gold mining equities terrifically interesting now.

Grant is a gold bug. You need to take his bullishness on gold with a grain of salt. The fact is that gold in US dollar terms is still in a long and depressing bear market. It had a nice rally on Friday, but so did the rest of the beaten up commodities sector.

But as I keep saying, gold priced in Aussie dollars is a different story. Currently trading at over $1,600/oz, well run Aussie gold miners are making good money in this environment.

Check out the chart below. As you can see, the Aussie dollar gold price spiked higher from November to February last year. Was that a sign of an impending downturn in the Aussie economy?

I view gold as an economic hedge, not a hedge just against inflation as many people believe. It protects your portfolio against uncertainty. That big rally at the end of 2014 was a warning sign that all was not well with the Aussie economy.

It turned out to be a prescient move. Many stocks peaked in February and the all-important banking sector peaked in late March and early April. Since then it’s been all downhill for Aussie stocks…except gold stocks.

Subscribers to Crisis and Opportunity know all about this. Sometimes, the opportunity is not where you expect. So don’t look to beaten up bank stocks as the ‘opportunity’ in this latest ‘mini-crisis’. They led the rally on the way up and they are leading the market down. It’s time for a new group of winners to take over the mantle.

Regards,

Greg Canavan

Editor, The Daily Reckoning

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
Reddit

Leave a Reply

Be the First to Comment!

Notify of
avatar
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au