Yesterday I discussed Australia’s two-handed economy. That is, on the one hand things looked pretty good with low levels of unemployment, but on the other there was little wage growth to speak of in an unproductive economy.
And that’s because the economy relies on shorter term stimulus for its growth. When that stimulus runs out, the economy falters.
The Australian economy has had no major stimulus since mid-2016 when the RBA last cut interest rates. But we have had the benefit of an upturn in commodity prices since then, so that has certainly helped.
Given the last interest rate cut was nearly two years ago, house prices and construction are now beginning to wane. That will take some momentum out of the economy at a time where the global economy may be at a cyclical peak.
The Aussie dollar is a good proxy for the health of the global economy, especially in a world where China is one of the main drivers of that growth.
In recent months, you’ve seen the dollar’s momentum shift downward. As you can see in the chart below, since the global upswing began in early 2016, the dollar moved higher. But it peaked in January along with global stock markets, and recently broke below 75 US cents.
This signifies a potential change in trend. In turn it could also signify a slowing of the global economy.
So, how do you invest in such an environment? How should you think about positioning your portfolio?
This is, of course, a difficult question to answer. People like to deal in absolutes. But in investment markets, there are only probabilities. All you can do is invest with the highest probability outcome in mind.
For example, at the end of 2017, I told readers of my Crisis & Opportunity report that 2018 would more than likely see a decent correction unfold. We therefore had to play it safely.
Since then, I’ve selected stocks with a defensive mindset. That is, I thought there was a decent probability that the market would go nowhere for a while, and would possibly turn down into a more prolonged bear market.
That’s why, even now, I’m looking for stocks that are in their own cycle, rather than stocks that are locked in the market’s cycle. This is where looking at charts comes in handy.
If I see a stock or sector that has underperformed the market over the past few years, and there are fundamental reasons to believe it will improve, then there is a decent probability that that stock or sector will increase in value even though the market goes sideways or backwards.
For example, last year I recommended a bunch of oil and gas juniors. They had been through a rough time thanks to the oil bear market from 2014–16, and had deeply underperformed the market. But they were turning the corner…
Now, not quite 12 months later, those stocks are all up double or triple digits thanks to good operational performance, a turn in the oil price, and improved investor sentiment.
You’re not seeing opportunities like I saw in oil in 2017, but there are still individual stocks that have great potential. This is a stock pickers market rather than a market in which to pick ‘themes’, like lithium, or cobalt, or tech, or cryptos.
That was a 2017 story. In 2018, you have to be more discerning.
You also have to know what to avoid. Not absolutely, but on the basis of probability. This can help you outperform the market too.
Should you Avoid Banks?
In my view, the banks are a good ‘avoid’ candidate. They face considerable structural headwinds over the next few years. They are under pressure socially, economically, and politically.
Household sector debt is already very high and it will take lower interest rates again for it to get a decent boost. The RBA will only cut in the event that a global slowdown brings it on. That doesn’t look anywhere near likely now and if it does, it will not be good for the banks.
The market is also telling you the banks are in trouble. Look at the chart below. It’s the ASX 200 financials index, which is basically made up of the banks.
As you can see, the banks peaked in 2015 on the back of the ‘search for yield’ theme, a theme that saw investors mistakenly view equity as debt. Then when the commodities bear market continued, investors reassessed that view, and banks went into a bear market too.
As an aside, banks borrow in offshore markets. When a commodity bear market cuts Australia’s income, global investors view our leveraged banks as being higher risk, hence the sell-off through 2015 and into 2016.
The banks then recovered with commodities and the global economy. But they peaked in May 2017. A correction then unfolded, and in March this year, the sector broke below support that had held throughout 2017.
The chart looks weak. And it matches the fundamental outlook for banks. The dividend yields look enticing but they nearly always do. It’s not a reason to buy.
In this environment, avoiding the right sectors (like the banks) and picking the right stocks (based on individual characteristics) is the way to go.
Investing based on themes and trends continuing will get you into trouble.
Editor, Crisis & Opportunity
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