The Weekly Wrap

Market Update

ASX 200 Index (XJO)

The past week has been one of sideways trading, with a 50 point range for the entire week. The shortened week means that the market will be closed after the close today, until next Tuesday, 6th April. Daylight savings also finishes this weekend, so the market in Queensland will revert back to the 10am to 4pm trading day.

The longer the market trades sideways, the bigger the next move will be. We mentioned last week that the XJO had just broken a triangle pattern, with the 6740 level being a key support area. With a 200 point move higher to 6850 on Wednesday, the support seemed to have worked. However, the XJO has managed to fall back from this level and to avoid further falls, 6740 must be held.

Given markets tend to repeat past behaviors, the last time we traded sideways for an extended period was between June and November last year. That pattern was broken with the election of a new President in America, yet the rally has been sideways since December.

US Market Update

The first quarter of 2021 has passed and it was the worst quarter for US Treasuries in 41 years. Gold declined 11.5% in the quarter, which was the worst quarter since 1982. On the other hand, the US Dollar had the best quarter in 18 months, whilst the CCC-rated junk bonds sector was the best performer in the fixed interest universe for this time frame. This sector represents the junkiest of junk bonds, yet investors couldn’t get enough of them.

The Dow Jones Industrial Average (DJIA) has rallied 9.1% in the last quarter and the NASDAQ 100 is up 3% in the same time period. The NASDAQ 100 actually peaked on 12th February this year and is down 5.1% since then. This reflects a fractured market which is not a bullish signal. Markets tend to move in unison when in bull or bear markets and this disparity between the indices tells us that change is afoot.

In the past year, the Central Banks of America, Japan and Europe have added US$8 trillion to their balance sheets in an attempt to force borrowing, via a low interest rate policy designed to make banks lend money to stimulate growth in the global economy. The current debt – to – GDP ratio has soared to 355% in the past year alone and this is now threatening any economic recovery in a post COVID-19 world.

One consequence of this easy money policy is when rates start to rise and the borrower defaults. Last Friday, a hedge fund in America called Archegos Capital defaulted on a debt payment and as a result, the lenders immediately sold the stock they were holding as collateral. The subsequent sale of US$20bn worth of shares saw some shares fall as much as 60%, such as Viacom in the chart below.

The banks who lent Archegos the money are set to lose about US$10bn, with Credit Suisse losing the biggest portion. This will most likely wipe out any profit the banks shareholders were hoping to see. This may give these banks a reason the rein in their lending in order to avoid any future forced sales.

You can combine the Archegos crisis with the recent closure of Greensill (a reverse factoring company), Robin Hood and the GameStop debacle to join the dots that all is not well in the security lending business. Rising bond yields flow into the credit market and with the world drowning in debt, this would be the worst scenario possible.

Do Economists Matter?

Do you ever read a forecast from an economist and shake your head?

The dismal science (as it is called) is relied on by politicians to make policy decisions, yet when pressured, economic policy is not reliable. The issue of course is that economists make forecasts on data that is sometimes 12 months out of date. They also assume that humans make rational decisions when investing.

The housing market in Australia is a hot topic at the moment, with certain pockets seeing some solid growth. Interest rates are low, supply is limited and there is a perception that prices will continue to grow indefinitely.

If you relied on the economists at ANZ Bank, you would be in a bit of trouble. This was a forecast made in August 2020:

ANZ: Melbourne house prices to fall by 15%,
Sydney not much better

We know that things were grim back then and the bank cited weaker household income, 10% unemployment, lower demand and higher uncertainty.

Fast forward to now and the bank has joined the bandwagon with the following forecast from March 4th:

ANZ: House prices to rise 17% nationally in 2021

Apparently, low interest rates and relaxed lending conditions will drive prices up this year, according to the same forecasters. No mention of the weaker income or lower demand this time.

The chart below shows the nature of forecasters. They operate in an environment that looks backwards to make forward looking statements.

Common sense suggests that the people paying record prices now may regret this if and when, interest rates start moving higher. Long term interest rates in Australia average 7%. Currently, the market is seeing a surge in borrowing on a fixed rate below 2%.

It would appear that economists fall prey to the prevailing sentiment of the time. They tend to extrapolate a trend and forecast it to continue.