Interest rates, record stock market highs and meme stock mania

Despite rolling lockdowns in Australia’s two largest cities and the rise of the Delta variant in the USA, stocks markets have continued their upward grind to record highs.

August is the continuation of US Q2 (second quarter) results, and thus far FactSet reported that 87% of the S&P500 companies have beaten EPS estimates. This is the highest EPS outperformance in percentage terms since FactSet began tracking the metric in 2008.

Although it is early days for Australia’s corporate reporting season, and the bulk of ASX companies have yet to announce their 2021 results, this August is expected to be one of the strongest since 2004 and most positive when it comes to dividend payments and share buybacks. It’ll be raining dividends!

So, what’s been happening and what should you be looking out for?

Global liquidity remains at record levels

Goldman Sachs issued a report in late June that highlighted there is now a record US$5.5 trillion of cash in money market funds still looking for a home.

The reason? A notice appeared on my CommSec page regarding the interest rates paid on international foreign currency deposits, which goes some way to explain.

The notice stated the current interest rate applied to the positive balance on a Swiss Franc (CHF) cash account is -2.0% for balances up to 100,000 CHFs and -4.25% above the threshold (and yes, I checked this number).

Euro denominated deposits were relatively painless in comparison at -0.80% and -1.05% under and over the threshold (80,000 EUR), respectively, and Japanese Yen -0.4% and -1.05% under and over the threshold (100,000,00 JPY).

In layperson terms this means depositors are being charged to hold cash in these currencies as interest rates are negative, with the Swiss Franc accounts being the most punitive.

With negative interest rates in some countries and zero rates in most of the western world, is it hardly surprising that equity inflows into stocks markets have remained high?

Retail investors have also continued to seek out higher returns in the share markets.  The expression used to describe this phenomenon is called the ‘TINA’ trade, or ‘there is no alternative’.

Inflation and interest rates drive equity markets

 Anyone watching the global interest rate benchmark, the US 10-year Treasury bond, would know the yield moved off the July 2020 lows of 0.5% to a high in February 2021 of 1.75%, then fell as low as 1.12% in the first week of August before doing an about face and backing up to the 1.35% level.

These are not small moves for the bond market and debate continues to abound about where the US economy is in the economic cycle. Will inflation move beyond the Fed’s ‘transitory’ view to embedded and potentially worrisome higher inflationary expectations?

Transitory implies a few months of year-on-year (YoY) and even month-on-month (MoM) growth in inflation due to the pandemic-induced supply constraints and above normal consumer demand in a re-opened economy.

Higher inflationary expectations means that inflation continues to rise year-on-year at higher levels of change (percent).

The latest US July CPI figures (seasonally unadjusted) came in at 0.5% MoM and 5.4% YoY but the underlying CPI (excluding energy and food) was lower than expectations at 0.3% versus 0.4% expectation.

The US July PPI (producer price index) came in above expectations at +7.8% YoY and 1% in July. This was a higher-than-expected result.

This means that producer prices are rising higher than what consumers are paying, inferring the producers are experiencing higher costs and margin pressure.

While some commentators infer this will result in ongoing higher inflation as the costs are passed through, other commentators are suggesting we should wait and see how the supply chain constraints evolve and whether consumer demand remains elevated.

If you were hoping for an end to the inflation debate and therefore the constant flipflop trading between growth and value stocks (in both Australia and the USA), then don’t hold your breath. The transitory versus embedded inflation discussion will be with markets for a while to come as investors and central banks see how the monthly numbers play out.

Comments from the members of the Federal Reserve Board are starting to flag the possible commencement of the tapering of the bond buying program. Markets will be looking for a more definitive discussion at this year’s meeting of the Federal Reserve board at Jackson Hole in late August.

Remember that tapering the US$120 billion bond buying program is not the same as raising interest rates. Increasing interest rates, remains a story at worst or best (depending on your views) a 2023 story in both Australia and the US.

In the world where bad news is good for share markets, more benign inflation figures are supportive of equity valuations and higher or much lower inflation than expected flags warnings bells that interest rates will have to rise sooner, or the economy has passed peak growth.

Here is an informative YouTube from Charlie Jamieson at Jamieson Coote  Bonds on how they see the bond markets and interest rate settings, which have relevance as to how the equity markets and stocks such as ‘growth versus value’ will be impacted.

Beware of meme stock mania

 As already discussed there remains a lot of liquidity in the global financial system and pockets of extreme exuberance can be evidenced with the irrational trading of the recent IPO, Robinhood (ticker code HOOD).

As one Twitter commentator noted “So $HOOD already doubled, crashed and then became a Reddit meme while also did a (sic) insider share dump and was a short squeeze all in the first 5 days of trading? Totally normal.”

I recently recorded a podcast with Kylie Purcell at Finder to discuss Robinhood which is available at this link.

In the olden days, the phenomenon was usually referred to as the hot stock of the day, week, or month when all the retail punters would jump on board the momentum trade without a care in the world regarding fundamentals.

In the last couple of years, the rise of the “meme stocks” has been fuelled predominantly through social media, the Reddit crowd and zero cost trading platforms such as Robinhood or eToro.

If one of your stocks turns into a meme favourite, then you are likely to experience extreme price moves or, in the recent case of Moderna, a doubling of the stock price in a couple of months.

A while back, I purchased Moderna to secure exposure to a leading mRNA technology and vaccine producer with an expectation that the spread of the Delta variant would drive demand. Did I expect the stock to double so quickly? Certainly not, which led me to take profits.

Moderna seems to have ‘done a Tesla’ in terms of the stock price. By this, I mean it has become a winner for the Reddit retail crowd and a meme stock. Whilst the mania for buying a meme stock is great if you happen to own it, the fact remains that fundamentals are often thrown to the wind, meaning the upside and the downside moves can become exaggerated.

More interesting listening and reading

If you are seeking some further food for thought on how the spread of the Delta variant may impact on share markets, I recommend listening to the recent Betashares economic overview from David Bassanese. Here is the webinar “Will Delta derail the equity rebound”

Some of the main talking points are:

  • The Federal Reserve and the RBA will not raise interest rates until 2023;
  • The US 10-Year Treasury Bond will move between 1.5-1.75% in 2021;
  • Inflation will be transitory;
  • Currency equity valuations will be supported by the interest rate settings;
  • The stock markets will be driven by earning upgrades in the US;
  • The outlook for Australian materials stocks is more challenging resulting in a weaker Australian dollar. I also think there are some valuable takeaways about affordability in the Australian property market,  and David’s view on decarbonisation and the Betashares Earth ETF (ticker code ERTH).

If you are seeking a good go-to analysis of the Australian corporate earnings season, I highly recommend FNArena’s Corporate Results Monitor.

Conclusion

That’s all for now folks, so until next time, stay well and safe. Remember that markets go up and down and patience is your friend to pick up great stocks when they are sold down.

Disclaimer: Shareplicity offers information that is only general in nature. It does not take into account your personal financial situation, needs or objectives. Nor does it take into account the financial needs of any specific person. You should consider your own personal financial situation and needs or seek financial advice before making any decisions based on this information.

 

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