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The Battle Between Dr Copper and Mr Market

The Battle Between Dr Copper and Mr Market

US stocks are within a whisker of breaking into all-time highs again.

The positive earnings US companies are reporting is driving the market higher, trade war be damned.

2018 may yet prove to be a very profitable year for investors. But they’ll have to earn it.

It’s a been a choppy ride up since the market tanked in February. Since then, there have been a spate of worries plaguing the market, not least rising interest rates and the simmering spat between the US and China.

Then again, what’s new? The outlook is never clearer than blurry.

But what about the news that the iron ore price is going up? This goes against the script. It’s now around $70 a tonne again, surging 2% in recent trade.

That’s important in light of the market’s recent attitude towards the Aussie dollar.

I’ll explain.

Aussie dollar forecast hooked to iron ore

At present, hedge funds and traders are taking out substantial bets against the Aussie dollar versus both the yen and the US dollar.

A big part of the bear case, according to Bloomberg, is a deteriorating outlook for iron ore. Considering the price rise, those traders might sleep a little less easy tonight.

I’ve made the case previously that the Aussie dollar might find support around this level as LNG and coal prices stay high and iron ore at least holds a line.

Primarily, it was an observation that the Aussie dollar generally moves alongside the commodities sector, as opposed to interest rate differentials.

In any case, our smaller natural resource export markets have taken a fair hit in the last month or so from Trump’s overtly aggressive stance on trade.

In fact, if you take your cue from ‘Dr Copper’, the diagnosis would be that the world is going to catch a cold pretty soon. Since early June, the copper price has swan-dived. See for yourself.

Source: Optuma

Should we take our cue from copper prices or US stocks?

My view is that the US is so strong, it can’t help but drag the rest of the world along with it for now.

And until the ‘trade war’ moves beyond threats and rhetoric, I’m holding firm that both the US and Aussie stock markets will be placed higher than where they are now by the end of the year.

After all, the investors pushing US stocks back up right now are doing so in the full knowledge of what’s happening.

In fact, there’s an excellent case for investors to hold US stocks should Trump be brought to the negotiating table and things settle down.

That’s because they could feasibly add almost $2 trillion in value to the US market in a fairly short space of time.

Here’s how, as first described by Peter Eavis in the New York Times.

US$1.8 trillion back in play if this multiple goes back to where it was

In the three months to February, the S&P 500 traded at around 17.8 times forward earnings — the estimate of earnings for the next fiscal period.

The worries over Trump’s trade policy has since suppressed this figure to 16.6 times.

If the market was to trade at the higher multiple again (17.8), it would add 7.5% or 3,000 points to the value of the current market. In dollars, that’s US$1.8 trillion.

And the outlook now — discounting the trade spat — is arguably better for US stocks than it was previously. The current quarterly earnings are beating expectations across the board.

The US Federal Reserve has clearly signalled its intention to raise rates twice this year. And inflationary pressure in the US economy remains modest.

Meanwhile, the 10-year yield is still under 3%. The fear around yields surging earlier in the year has dissipated for now.

So there’s plenty of scope for US stocks to move up from here.

Naturally, we can’t ignore the bear case. If trade war relief can take the market up, an escalation can take it down.

Ultimately, it depends on what type of investor you are. If you hold the ‘market’, then you’re potentially in for a big month as the final decision on the next round of tariffs looms closer.

If you invest in individual stocks, many will carry on their present course regardless of what happens.

It’s important not to forget that.

I mentioned the other week how Carnarvon Petroleum, a small Aussie energy explorer, hit a significant oil strike in the waters off the coast of WA. Its shares are up over 200% since mid-July.

The market will still rerate any stock that hits oil or gold or whatever the catalyst happens to be while this trade war argy-bargy goes on.

After all, if China is going to hit US oil with tariffs, their refineries will still need to source it from somewhere else.

That is to say, there’s still plenty of opportunity to make money in stocks. If anything, investors looking for strong potential returns could consider adjusting their strategy toward stocks.

The broader market is likely to tread water until the trade issue is resolved one way or another.

Regards,

Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia