Stocks Shrug off Turkey

Stocks Shrug off Turkey

US stocks had a big session overnight. The Dow Jones had its best day since April.

All in all, the market looks bullish going into the second half of the year. And no wonder.

The earnings coming out are good. Management teams in the US are upbeat about the short-term outlook.

Retail sales especially have come in a lot stronger than expected as US consumers go shopping. Walmart says it saw the best quarterly sales growth in a decade.

US stocks can certainly rise from here, lifting the ASX with it.

Goodbye long-term bonds

Here’s one reason why US stocks could be in for a lot more fun.

I came across an interesting market video this week. It pointed out that long-term bond prices are weakening relative to the US stock market.

You have to put this into a very long-term timeframe to get the point.

Imagine for a moment the typical US investor in the year 2000. It’s highly likely their financial adviser gave them a portfolio that was half long-term bonds and half US stocks.

Over the last 20 years or so, it wasn’t a bad way to go about investing. Both asset classes have done well.

But the main point is that when the US stock market dived, bond prices went up. This dragged down the overall risk and volatility of the portfolio.

But something notable happened with long-term bonds when the US stock market tanked in February. They went down too!

Something about the old relationship broke from the norm.

This is a relationship we need to carefully watch going forward. A lot of money could shift out or away from the bond market and head into US equites instead.

Big money in the market that needs fast returns

It’s also interesting to note that the Wall Street Journal reported recently that US pension funds have a major problem: Their assets aren’t enough to cover future liabilities. They need growth of 7–8% to keep meeting their commitments.

One consequence of this is that they’ve raised their percentage allocation to stocks. This is also pumping more money into the share market.

The pension funds are also allocating money to private equity and hedge funds. Bonds are losing appeal because yields are lacklustre.

This might be part of the dynamic that takes the share market to a top. Investors may be tempted to overreach.

Consider: Two of the biggest pension funds in the US are for Californian teachers and civil servants.

One of them is knowns as CalPERS. They’re paying out huge sums — and the demand on their financial resources is going to worsen.

This quote, via the Wall Street Journal, comes from Dane Hutchings, a member of the investment committee in June:

Its crunch time, and quite frankly, we simply cannot stand another market slowdown or substandard returns.

Mr. Hutchings warned of impending municipal bankruptcies and urged Calpers to shoot for higher investment returns to forestall layoffs and cuts to public services.

The Fed’s dilemma

I get the impression Mr Hutchings’ urge to ‘shoot’ for higher returns has an element of ‘hope and pray’ about it.

This is the kind of problem that can stay obscure until something happens to bring it into the spotlight.

However, for now, the US economy should keep chugging along. The US Fed released its latest survey on credit conditions. Debts are at a record high as people keep borrowing to buy houses, cars and go to college.

There have been a few sceptical eyes in the last couple of years that keep pointing out these debts can’t rise forever.

This is true. The credit cycle will turn at some point. However, low unemployment and low rates are providing support for the moment.

The number of borrowers in delinquency is also way down from its major peak in 2009. So no signs of stress there.

Of course, we need to remain alert. It’s always when things look rosy that you run the risk of letting your guard down.

A strong America sets the lead for the rest of the world.

That’s why the biggest variable to watch now is the US dollar. It’s causing severe stress across emerging markets and commodities.

Currently the market is anticipating that the Fed will raise rates two more times this year. But this will, if it happens, suck even more money back into the US and strengthen the US dollar even further.

This might worry the Fed because it hurts US export competitiveness.

The Fed may actually pause things where they are now for a little longer than anyone thinks. If that were to happen, stocks could soar as the market prices in easier monetary policy for longer.

That’s a thought, not a prediction. Either way, the rest of 2018 is shaping up to be very interesting indeed.

Regards,

Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia