Global ‘Big Three’ to Fire Stocks in 2018
It was a big day over in the US bond market as we were all sleeping last night.
The US Treasury held record sales of government debt, known as T-bills. These are short-term loans of three and six months.
It raised US$151 billion from these sales. US debt numbers are never small — that’s for sure.
It was notable because demand fell to its lowest level since 2008. That would suggest investors are wary of rising interest rates now.
The yield on a two-year note went to its highest yield in a decade.
Inflation is rumbling, and the bond market is reacting.
This is threatening to make the yield curve ‘inverted’ some time in the future…
A reliable indicator of recession
The US yield curve is a wider watched measure in the financial world. It plots the different rates you can earn buying bonds, which mature at different lengths of time.
The longer you’re willing to tie up your money, the higher the rate you need to compensate for the extra risk. That’s the normal state of affairs.
This means the yield curve slopes upwards under normal conditions.
However, this curve is ‘flattening’. That means the difference between short-term and long-term rates is becoming narrower.
And why do you care?
If short-term rates go above long-term ones, then the yield curve is said to be ‘inverted’.
This has a reliable pattern of happening before a US recession.
The US Fed is on track to raise short-term rates three times this year. This is in response to America’s strong economy.
That’s what is being priced in for the moment. But it’s quite possible the Fed could raise rates four times.
That could cause a big adjustment in the bond market…and send markets into another period of volatility, like we saw the other week.
We’d also be on watch for a slowdown in the US within two years.
But it hasn’t happened yet. It’s something to keep in mind.
So we’ll keep tabs on how things develop from here. It’s fair to say the days of ultra-low interest rates are behind us.
But what’s ahead?
When the ‘big three’ all fire at once
One suggestion is to keep an eye on Europe.
The Wall Street Journal reports that half the companies in the major index over there have beaten their earnings estimates.
And hey, if you’re planning a trip to Spain anytime soon, get there quicker rather than later.
The price of the delicious ham (‘jamon’) they dish up over there is up 40% over the last year.
Demand must be up.
Way back in 2015, I actually wrote that Spain should see a strong comeback.
My suggestion was to buy some real estate over there if you could. I should have added a few legs of their delicious pork, for good measure.
Everything is easy in hindsight!
My base case for 2018 is that we’re going to see the ‘big three’ economies of Europe, China and the US all fire at the same time since before 2008.
The Australian reporting season is going okay. Credit Suisse says analysts have upgraded their earnings estimates against downgrades by the biggest margin since 2005.
Some big misses — CBA, Fletcher Building and Wesfarmers — are obscuring a pretty strong backdrop. Dividends for the full year could equate to an additional $500 million once June rolls around.
We can thank commodity prices, mostly. Miners are making good money at these prices.
One notable outcome from this is that they are still highly stringent with what they do with it. They’re paying down debt, and leaning towards stock buybacks and dividends.
It means they’re not yet splashing out on big acquisitions or announcing major expansion plans.
That should make the share market a happier place to be for the moment.
However, I do wonder how long it can last.
Miners don’t have the luxury of doing this indefinitely. They’re constantly running down their existing reserves.
I expect action around the resource market to heat up at some point.
There won’t be a shortage of money if current spot prices in the commodity markets hold up.
BHP could see the second half of the year generate 150% more free cash flow than the first half.
There’s a lot of variable for that to happen. But it’s fair to say that BHP’s mainstays — iron ore, copper, oil — are looking strong for the foreseeable future.
That gives the Australian resource sector a bright outlook.
One thing though… My colleague, Jim Rickards, suggests that gold is actually the pick of the bunch.
To find out why, go here.
Editor, The Daily Reckoning Australia