My usual task on my Monday note is to try and pick up on early trends on where market interest might be heading. Before October last year, when stocks took off, I argued the case that eventually falling interest rates will be good for tech/growth companies and small cap stocks. Individually, a company like Zip Co. fitted that bill and has spiked 380% over the past six months!
That’s small cap, tech-oriented and interest rate affected and so the prospect of lower rates has been a part help but so was the market being too harsh on the business.
On the other hand, I often remind subscribers that quality companies get mistreated by the market consensus, temporarily. In recent times, the likes of Resmed, Xero and Macquarie have been cases in point.
We’re still waiting on CSL to deliver but, right now, the consensus view is for this world-class performer to reach $316.73, which would be a 12.4% rise from the $281.70 it’s currently priced at. Six out of six analysts like the company, with both Macquarie and UBS tipping a 17.5% rise over the year but a recent news story reported that Macquarie can see CSL as a $500 stock in three years’ time!
That’s a huge call but I think the case for holding or buying CSL looks better than OK.
However, for this week, these ‘smaller picture’ stories must take a backseat to the big pictures of the fear of sticky inflation delaying rate cuts and the prospect of a real hot war involving Iran, Israel and undoubtedly the USA
Despite the best efforts of some commentators (who tend to forget how bad some of their outrageous price slump calls were), when it comes to stock prices and house prices, these ‘experts’ are now warning that inflation could lead to rate rises. As Billy Joel might sing, they could be right, they could be wrong, or they might be crazy.
I prefer to argue the rate cutting time will be delayed but it will happen, and the work of AMP’s Shane Oliver with his Inflation Pipeline Indicator for the US (which has proved very reliable) tells us to expect lower inflation for the Yanks going forward.
This is what he said last Friday following a CPI coming in at 0.4% for March, when 0.3% was expected and the Producer Price Index printing at 0.2%, though 0.3% was tipped by economists: “Our US Pipeline Inflation Indicator has edged up but is still averaging around a level consistent with 2% inflation. So, while inflation has surprised on the upside so far this year, we continue to see it resuming its downswing as wages growth continues to slow, allowing the Fed to start cutting rates in the second half. Expectations for Fed interest rate cuts have swung from extreme optimism earlier this year (with seven cuts priced in) to extreme pessimism now (with less than two rate cuts priced) and are likely at some point to start swinging back the other way.”
And here’s the chart that makes me think that if the market wants to sell off on persistent inflation fears and no rate cuts, I will see it as a buying opportunity for individual stocks and exchange traded funds, such as VAS, IHVV and GEAR (for the real risktaker).
Note above how the black line (which is the Inflation Pipeline Indicator) has led the red official CPI line.
I will rest my case on this subject. But what about the thorny issue around Israel and Iran, and potentially a US involvement, which President Joe Biden has said will happen if Tehran decides to go all out into war.
Undoubtedly, the market would react negatively to any real war scenario but history (which I’ve shared with you in the past) says the overall stock price reaction can be selective and short term.
This table sums up many a geopolitical challenge for share prices, so let’s see which one might be the most potentially relevant. It looks at Market Shock Events with a focus on the total drawdown for share prices and the time for market index recovery.
What you see is that with many internationally worrying events, the bounce-back of the market was quite short and the overall impact on stock prices wasn’t all that worrying.
Two relevant ones to look at are the US Terrorist Attacks of 9 September 2001, which also coincided with the Dotcom crash of the market. So, there were two concerns simultaneously. That recession started in March 2001 and went on until November, so the fact the total drawdown was 11.6% — a correction — and it recovered those losses in 31 days, suggests stock markets can overreact to bad news but then they eventually see the buying opportunity!
Next was the Iraq Invasion of Kuwait, which saw the US get involved on 8 February 1990, which correlated with a US recession that also hit Australia. This recession started in July 1990 but, of course, the economy was weakening before that time, as a technical recession isn’t declared until there are six months of negative growth. Here the drawdown was a bigger 16.9%, so it wasn’t a crash, but the concern is the recovery for the market was 189 days.
However, the table says the bottom of the fall in stock prices was after 71 days — just over two months — and that’s when a buying opportunity arrived. That means in both cases the sell offs both coincided with recessions, which aren’t on the cards in the USA. In fact, the Yanks have a ‘too much’ growth problem, so that takes away one negative issue for stocks.
Of course, if Iran steps up its attacks and then the US actively gets involved, the market reaction will be substantial in the short term. But if their involvement is more strategic and supportive, then the sell off might be akin to what we’ve seen with the Russia-Ukraine war.
The Russian invasion of Ukraine was on 24 February 2022. Since that time, the S&P 500 is up 16.8%. And over that time, it was hit by 11 rate rises between March 2022 and July 2023, which clearly took a lot of wind out of the US stock market’s sails. In fact, it coincided with a near 21% slide in the index.
Given interest rates are more likely to fall rather than rise this year and a US recession is unlikely, and provided a US involvement in any Israel-Iran war doesn’t happen, then the stock market reaction should be manageable. And smart players will be looking for buying opportunities.
For the sake of the people of Israel, Iran, and the US, as well as the stock market, let’s hope current concerns are greatly exaggerated.
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