Key Points
- Global equity markets breaking out in global economic boom!
- US a leader but Germany and India also in vanguard
- SE Asian markets finally breaking higher
- Global bond market is US$100tn in long and wrong positions
- Massive bond sell off to provide ample funds for equities and commodities
- Economic activity to accelerate everywhere
- A$ to remain firm
- Resources stocks are still unloved and underowned
- Major rerating expected
Preferred stocks ASX.BHP, ASX.RIO ASX.FMG
Observing world events at this extraordinary time is a truly inspiring experience. The Trump emergence and the reaction of denial and hysteria from so many sectors is fascinating. The changes taking place are of epic proportions and the world appears to be at a major watershed moment. It seems the world is moving from a certain period of fantasy back to reality
Watching global equity markets and also the bond markets is actually quite exhilarating because these developments are truly once in a life time events. I have said it before but these are times you will be able to tell your grandchildren that you were there.
Equity markets are breaking higher in a massive bull market.
Bonds have peaked and are on the way to eventual collapses and probable oblivion for many issues and issuers.
Dawes Points has been resolute in maintaining the same consistent story for some time and, apart from the undeserved weakness in my own resources sector itself, everything in the outlook of the past few years has just about come to pass.
The US didn’t slip into the Greater Depression, the US equity market didn’t collapse, China didn’t implode, the European banking system didn’t collapse and the Great Australian Recession of 2014/15/16/17… hasn’t happened.
The A$ didn’t dive to sub US$0.50. The iron ore price is not US$20/t. Oil isn’t at US$20/bbl.
In contrast, global equities are making new highs, global economic activity has improved and resources consumption has continued to grow.
So let’s review it all for the fabulous bull market unfolding for most things and resources in particular.
The equity markets outside Australia are now booming on as noted but first let’s look at the global bond markets.
The bond markets are currently far larger than the equity markets. This is mostly due to government budget deficits in so many nations where social spending is growing along with ageing populations and also an ever-growing range of services that politicians bribe with and voters demand of government.
The artificially low interest rates have allowed these expenditures to continue but now this game is over. Interest costs now make up a significant proportion of budget expenditures and as the coupon interest rates demanded for bonds keep rising, that proportion can only increase.
Many governments may be issuing sub 2% coupons on 10 year bonds today but in another year or so the rate may be 4% and the interest cost share of budgets might just double given that most bonds issued to date have not been 10 years but are in fact very short dated.
Globally, the US 10 Year Treasury Note is a critical component in the outlook for all bond markets.
It is probably the largest individual component of the global bond market and it sets the global `risk-free’ rate.
You need to be able to imagine that the `price’ of a 10 year bond is a moving feast and so a `price index’ must be made up of a collection of a wide variety of bonds with exactly 10 years to maturity. This can be 30 year bonds issued 20 years ago, 20 year bonds issued 10 years ago and current new 10 year bonds. The interest rate from the time of issue (`the coupon’) could be 12, 10, 8 or the current 2.4%.
The bond price index is thus a true cocktail.
This index, however, peaked back in 2012 and has been telling us all something of what is to come. Sharp initial falls, partial recovery then more sharp falls. More falls to come.
To understand all this you should be aware of how bond pricing works and what might soon be happening in these markets.
A simple assessment points out that rises in interest rates cause falls in the price of bonds and falls in interest rates cause bond prices to rise.
Also increased buying of bonds can increase bond prices to drive down yields (interest rate coupon divided by bond price, e.g., simplistically, 5% pa paid as $2.50 half yearly on a $100 bond so bond buyers bidding up the bond price to $105 will only get $5/$105 = 4.78%,).
Selling down of bonds to $95 gives a higher yield of $5/$95 = 5.26%.
The selling of a bond may reflect the holder’s wish for liquidity and not the overall interest rate environment.
Here also the lower the coupon on the bond the higher the price volatility.
And, the longer the duration of the bond the higher the price volatility.
The world now has a lot of low coupon bonds. So expect high bond price volatility.
Note the fall here in the 10 year bond from 133.21 in mid 2016 to 125.36 has given a capital value 5.3% lower and that bond now has only 9 years to run.
If you bought that bond at the yield to maturity of 1.35% in July 2016 you have already lost in capital the equivalent of 4 years of 1.35%pa income.
Remember last year when you were told the world was seeking income at any price. Sell your 2,3,4,…..5% yielding stocks and buy 1.35%pa 10 year bonds. What a bargain!
With the 30 Year T Bond the stakes become much higher.
A year ago these bonds peaked at 176.06 when yields were just 2.1%. Buyers then are now 29.6 points or 16.8% less wealthy and have lost 8 years of 2.1%pa income in capital losses.
Unlucky.
The long term for bonds looks just awful. Very unlucky if you own these instruments.
A very long term Rising Wedge has been in play for some years.
The deadly rising wedge has uptrends having lows in price rising faster than highs in price and at resolution usually falls sharply.
The US 30 Year T Bond has a 35 year rising wedge life history. Note the sharpness of the fall from that July 2016 high of 176.06 to 146.46 in March 2017. Nine months and 29.6 points is 16.8%. The next fall would be to 140 and then to a target of about 120 – equal to about ~20% capital losses in `risk-free’ investments.
Very unlucky.
Now this is the bond market for the US of A. It is not Italy. Or Spain. Or Greece.
Have a look at these numbers on the US Budget. The numbers from www.USFEDERALBUDGET.com are actuals and best guess forward estimates. These may be different to other numbers currently circulated but they are a fair indication of the trends.
Some important things to note.
The deficits are well down on the peak years of >US$1000 over 2009-2012 but even with a recovering economy the deficits are growing again as the interest rate cost rises.
Interest expenses could rise from 6.5% of all other expenditures (6.1% of total Budget expenditures) in FY2016 to 12% by FY2020.
And look at the projected average interest rate of 1.90% for FY2020 and compare it to FY2017 at 1.49%.
Now look at this Projected Maturity Profile from the US Treasury (late 2015 I know but I could not find a more recent version. Why?) which shows <12% was longer than ten years and >65% shorter than five years.
Source: US Department of the Treasury August 2015
You could feel despondent about all this but rather than think about bond markets setting the interest rate level you should see this ~US$100tn globally as a wonderful source of capital.
The capital that has for years been denied to you to develop your project.
Keep in mind that the world should get by with 5% Ten year bonds as it has for most of its history.
The market place and equities and commodities will withstand these falls in bond prices as the capital flows out of this overbought, over-owned and wretched asset class.
It is already.
The US Housing Sector thinks it is wonderful! Bricks and mortar before paper assets.
Housing starts seem to be having a normal summer seasonal breather and should turn up for the Dec Qtr.
Banks just love higher interest rates because they give improved lending margins. And a rising Fed Funds rate forces banks to lend more of their outrageous QE money to the general market place at last at much higher margins.
And hope you noticed that banks last year ended 14 years of underperformance against the S&P500 and are amongst the market leaders now. Clearly higher bond yields aren’t important here either. 
So coming back to other 10 year bond rates look at this graphic with the US 10 year, US 30 Year ($TYX), UK 10 Year, German 10 Year and Japan 10 year included. The `negative interest rate’ hysteria was the top of this bubble!
Just as the US ten year bond has broken a nine year downtrend so have German and Japanese bonds. The UK is just at its downtrend and about to break through as well.
So back to equity markets and what about them?
The markets are speaking. While the bonds are selling off, equities are rising.
The Dow Jones 30 is making new highs and is accompanied by the Dow Utilities and Transports.
Nasdaq is making new highs.
And small caps indices like the Russell 2000 keeping making new highs. Remember when you were told to sell small caps and stay only with the large stocks because the end of the world was coming? More recently it was `FANG stocks were the only things pushing indices higher so watch out’!
So the US recovery is real and it is helping everywhere else and Germany is also leading the world to new highs.
India is next and what a leader this is. Loads of upside.
So much for Brexit bringing down the UK.
This Morgan Stanley Portfolio represents a composite of emerging markets and would include most Asian markets. The performances of Singapore, Thailand, Taiwan, South Korea, Philippines are similar to this proxy.
However, the most important markets are Japan, Hong Kong and Shanghai.
Japan is heading for new highs in this post-2009 rally.
Hong Kong is now ready to move substantially higher after a decade of consolidation.
Shanghai is parallelling the other markets and is now ready to approach and break through 3300.
In Europe as noted, Germany is leading with the UK next but France, Spain and Italy are also moving up constructively.
Closer to home, the New Zealand market has been one of the best performing indices.
What an outstanding run!
Which brings us back to Australia. The perennial underperformer.
But it could now be ready to play catch up.
Look at the ASX:XMM Metals and Mining Index.
The 2011 downtrend is broken and the index is getting ready to fly.
BHP, RIO, FMG and other resources majors are ready to run at last. (Note these are US$ prices in US market.)
Dawes Points has been an unrepentant A$ bull and should we break above about US$0.79 then a bigger rally should ensue.
And note also that the 104 year downtrend from 1913 comes into play at just over US$0.80.
So, what does all this mean?
Well, a major global economic boom is underway. It has taken much longer to develop than has been expected here but in turn it should now last much longer than you could imagine. Resources commodities from iron ore, coking coal, copper, aluminium, zinc, lead, tin, cobalt, gold, silver, palladium, platinum, minerals sands and much more will have higher prices. All will reflect record consumption demand, low inventories, insufficient new resource developments and not enough exploration.
Are you on board?
Make sure you have your portfolio together because big gains are coming.
Contact me to participate.
Barry Dawes BSc F AusIMM (CP) MSAFA
+61 2 9222 9111
bdawes@mpsecurities.com.au
Dawes Points #67
18 July 2017
