The Great Rotation Into Stocks

Well played, month of January. You exceeded everyone’s expectations. The S&P ASX/200 finished up six per cent for the month. Eleven more like that and you’re talking about a serious share market rally. Good luck February! We’re all counting on you.

Actually February doesn’t look like being outdone, at least if the US market action is anything to go on. The economically meaningless but nonetheless popular Dow Jones Industrial Index closed above 14,000 for the first time since 2007. It was the fifth-straight weekly advance for American blue chips, a veritable blitzkrieg of bullishness.

If you’re troubled by things that don’t make sense, then this share market rally will trouble you. It probably won’t trouble you too much if you’re making money, which is why it won’t trouble most investors. But the trouble, in any event, is that earnings expectations for 2013 are headed down for most stocks, not up.

That’s a problem because, well, if earnings aren’t going up, then all you’re really seeing is an expansion in the price/earnings multiple for Australian stocks. Earnings season is upon us in earnest. Instead of having a feeling about them, we’ll have facts. In fact, we already do have some facts!

There have been 21 profit downgrades for ASX/200 companies since August of 2012, compared to just three upgrades. According to the AAP, analysts are expecting just 3.0% growth in 2013. Analysts can and often are wrong, of course. But it’s a fair question: in what sector of the Australian economy will earnings grow fast enough to justify the prices investors are paying for stocks right now?

Don’t get us wrong. These aren’t the heady days of 2007, when the future was so bright that you seemingly couldn’t go wrong buying stocks. But there’s more than a whiff of euphoria in the air. Granted, it smells better than desperation. But it IS a kind of desperation of the positive sort.

Back in the real world where money matters, the high Australian dollar is contributing to huge cost blow outs in the extractive industries. The latest victim is Chevron’s Gorgon gas project. The project is about $14.4 billion more expensive than Chevron thought, with about one-third of that cost over-run being attributed to the Aussie.

If the Reserve Bank of Australia wants to do something about the dollar, it can begin doing so tomorrow. The cash rate sits at the ’emergency level’ of three percent, right where it was in the crisis days of 2009. Riddle us this, then, dear reader: if stocks are such a good bet right now, why are interest rates at crisis lows?

Where’s the crisis? Is it in consumer price inflation figures that are almost certainly higher than the official numbers? Is it in the affordability of houses? Is it a manufacturing sector that’s being gutted? Or is it your run of the mill, boring productivity crisis where unit output per person is stagnant?

The good thing about a crisis is that even if it isn’t always predictable, it’s usually reliable. It will come when it will come. In the meantime, there is another explanation of the move to stocks: they are not bonds or cash. Before you chortle, hear us out.

The machine that markets stocks to investors and peddles statistics to justify them for the long run is gearing up again. This time, its main message is that is a ‘Great Rotation’ out of cash and bonds and into stocks. Why? Because that’s what you do with your money when expectations about the future are positive! You take risk!

That is a lot of lipstick and rouge for a very fat and ugly pig. The simpler explanation is financial repression. Interest rates have been lowered to make it easier for governments to borrow new debt and refinance maturing debt. As a result, the rate of return on interest bearing securities is all out of whack with the real risk you take in buying them.

What do you do when even junk bond yields aren’t juicy enough to entice you to have a punt? You buy stocks! The move into stocks fits perfectly with John Exter’s description of how liquidity behaves in a monetary crisis. Liquid cash moves from debt-based assets into cash, stocks, and gold. The entire financial pyramid contracts as more money moves into fewer asset classes.

This is great news for the ‘keep it simple’ crowd. If the analysis above is right, blue chip stocks will become inflation havens and liquidity refuges. Investors will hide there because it’s the only place they CAN hide and still try to earn a return on their cash. It may not be the miners and the banks that lead the index. It may be the telcos, the big retailers, and the grocery stores.

The small caps tend to lead the charge when stocks rally. Will that be the case this year? Is it already the case? More tomorrow.

Dan Denning
for Markets and Money

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From the Archives…

The RBA’s Interest Rate Bait Isn’t Attracting Many Bites
1-02-13 – Greg Canavan

A Prediction for 2013: Days of Abundant Natural Resources to Continue
31-01-13 – Chris Mayer

The Evolutionary Path of Boobus-Politicus
30-01-13 – Joel Bowman

The Unbalancing Act Happening in China’s Economy
29-01-13 – Greg Canavan

Marginal Utility: Steps Toward a Better Life
26-01-13 – Jeffrey Tucker

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Dan wrote: “The economically meaningless but nonetheless popular Dow Jones Industrial Index…” Maybe if Dan, and Greg?, had a little bit more respect for the Dow, perhaps they wouldn’t appear to be so flat-footed by the present bull-market: “[The] blue chip indexes [were] at 12-year lows… The only other 2 times that saw the S&P or DJIA at 12-year lows over the past century were 1932 and 1974. In hindsight, both instances turned out to be the “buying opportunity of a lifetime”” (James Stack, Investech Financial Update,, March 6, 2009 – subscription). “On Wall Street, it’s been the “least… Read more »
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