Three stocks to defy current interest rate hysteria

Monday, 9 May 2022 — Albert Park

[5 min read]

Dear Reader,

The sun is shining through my office window this morning. How can it be? Hasn’t the world ended now that the RBA raised the cash rate to 0.35%?

Cue belly laugh! The more I think about it, the stupidity of the current hysteria around interest rates seems more ridiculous.

The big banks dominate around 80% of the mortgage market. APRA already pressured them long ago to raise their serviceability buffers to 5% for this exact scenario.

This happened before the pandemic. That is to say when rates were higher than they are now.

Most borrowers in recent years will have big buffers in place. Plus, we have the accumulated savings that COVID sent into offset accounts all over the country. Then we have the ‘equity, mate’ gains since the property market roared out of 2020.

And we’re supposed to break into a sweat over this…why?

That’s my take. But you can get more than my opinion on this.

We can glean insight from a company intimately attached to what’s happening in the property market.

The Australian Financial Review cites the chief executive of REA Group [ASX:REA] this morning. His company dominates the market for real estate listings in Australia.

Check it out:

‘REA Group chief executive Owen Wilson says he is not concerned about interest rate rises, arguing the fundamentals of the property market remain strong with buyers factoring in potential increases.

‘‘‘The interest rates are coming off very low settings and, even if all the predicted rate rises come through, it really only gets us back to where we were pre-pandemic,’’ Mr Wilson told the Australian Financial Review.

‘‘‘The market has already factored it in. Anyone buying or selling at the moment is doing so with a full expectation that these rate rises are coming, and yet, we’re still seeing really healthy levels of listings and transactions.’’’

I couldn’t agree more.

Here’s another snippet that I came across from a random source...

On Sunday, I read a book about the need to reduce wasteful consumption in today’s economy.

The author went back and looked at industries that were hit when US consumer income came under pressure in 2008.

What did he find?

Motor homes got the flick first. Car and boat sales tanked. Then discretionary things like carpets, jewellery, furniture, big household appliances, and airfares.

Hello!

Qantas just came out with a great update, saying that leisure travel was its strongest market.

Does that scream consumer distress to you?

My goodness, the market is discounting an extremely negative scenario when it comes to property.

I told readers of Australian Small-Cap Investigator the following recently…

None of the above looks very scary to me.

Add in increasing immigration and low unemployment, plus big government deficits, I’m not losing sleep over the housing market.

Let’s bring it back to our hunting ground: the small-cap sector of the ASX.

The three recommendations I have for you today are down 48%, 36%, and 32% from their all-time highs.

Why?

I already alluded to it. All those interest rate fears you’re reading about now are mainstream headlines. But the stock market moves way ahead of the general news.

That means fearful investors started bailing out on these stocks 6–9 months ago.

What does that mean to you as a small investor?

The fear around interest rates killing the property boom is built into today’s share prices already.

In fact, it’s the basis of the entire opportunity! Why else would these stocks be trading so cheaply?

The market has already priced in a very negative scenario. We only need future interest rate developments to be LESS bad than the market fears and these stocks should respond…by moving UP.

Put the headlines aside…

Every indication I have says these three are primed to fly again over the next 2–3 years.

Nothing I saw last week changed my mind on this. If you want to check out some ripping stocks to pick up at crazy cheap valuations, go here now.

Your future self should thank you!

All the best,

Callum Newman,
Editor, The Daily Reckoning Australia

PS: If the small-cap market isn’t entirely your cup of tea, my colleagues over at Strategic Intelligence Australia have a new model portfolio project underway that’s specifically calibrated for Aussie investors. You can learn more about it here.

Dear Reader,

Birds in the trees. Green, green grass. Wisteria cascading over the doorway. We’re glad to be back in our Irish cottage.

But stalking the emerald isle is the same menace that dogs the rest of the world. The Irish Times reports: ‘Irish inflation soared to 6.9% in March, EU says’:

‘Annual inflation in Ireland soared to 6.9 per cent in March, according to Eurostat, the statistical office of the European Union. The EU inflation measure differs slightly from the CSO’s consumer price index, but the two track each other very closely

‘By way of comparison, Eurostat’s estimate for Irish inflation was 5.7 per cent in February, and just 0.1 per cent in March 2021.’

All over the planet, prices are rising. Because all over the world, central banks followed the same recipe and baked the same cake. Lots of sugary free money. Loads of leavening. And each time investors began to feel sick — 2008, 2020 — they dumped in more Jim Beam and methamphetamine.

Ireland uses the euro. And euroland inflation is running at 7.5%...not far beyond dollarland inflation above 8%. In Turkey, inflation has reached 67%.

All over the world, too — except Japan — central banks say they’ve taken the pledge: no more inflationary monetary policies.

Last week, the Fed announced a rate increase of 50 basis points (0.5%).

The Australian central bank raised its key rate last week as well. The Russian central bank lends at 17%. And, naturally, Argentina is ahead of the curve…with a 60% lending rate.

So far, the European Central Bank has dragged its feet. But it, too, is expected to go on the wagon, with a ‘tightening cycle’, soon.

Does this signal the end of inflation? Have central bankers learned their lesson…thrown out the old Keynesian cookbook…and with their right hands solemnly laid on a copy of Ludwig von Mises’ opus, Human Action, vowed never again to do anything so stupid?

Not exactly.

Faux hawks

The Fed’s 0.5% rate increase brings the Fed Funds rate to a real level of around MINUS 7.5%. Even with yesterday’s rise, the ‘risk-free’ 10-year Treasury bond yields MINUS 5% or so. Can you really rescue a man from drowning at the bottom of a pool by pulling him up a few inches? Can you really stop inflation when you’re lending money at negative interest rates? Not likely.

Investors realised immediately that the Fed was only pretending to be ‘hawkish’. From Barron’s:

‘The stock market ripped higher Wednesday afternoon after the Federal Reserve delivered on its plan to fight inflation. The central bank hiked interest rates by a half-percentage point and started reducing the size of its balance sheet, which has ballooned during the pandemic.

‘The Dow Jones Industrial Average gained 932 points, or 2.8%, after the announcement. The S&P 500 rose 3%, while the Nasdaq Composite added 3.2%.

‘[Bond yields] dropped after the Fed signaled it wasn’t about to become even more aggressive in tightening monetary policy. The 2-year yield fell to 2.64% Wednesday afternoon, and the 10-year yield dropped to 2.92%.’

But what now? Is the inflation threat history? Is pilot Jerome Powell bringing the US economy in for a landing so soft the passengers don’t even know they’re back on the ground?

It would be one for the record books.

Meanwhile, back on Earth…

The problem is a familiar one — the wrong metaphor. A skilful pilot can pull back on the throttle, adjust his wings, raise the nose slightly…and set a plane down softly, even in a storm.

But no amount of mechanical skill keeps a man from getting what he’s got coming. The best weatherman on Earth can’t stop the wintry winds. And when the PhDs at the Fed go out for lunch, the waiter still brings the bill, no matter what their ‘dynamic stochastic’ models tell them.

The US economy has US$88 trillion in debt. The Fed turned the interest rate knob into negative territory; people took advantage of the opportunity to borrow at below-inflation rates.

And now, down on Earth…where the Fed says it intends to land…even a modest increase in interest rates could have catastrophic results. Just three percentage points, for example, would add more than US$1 trillion in interest charges for the federal government alone…and US$2.5 trillion more in total interest costs to the economy as a whole, an amount equal to nearly 100% of all US corporate profits.

Where would that money come from?

What would stocks and bonds be worth then?

And how about houses? Imagine mortgage rates at 10%. How many people could refinance their homes? How many houses would suddenly be on the market? What will happen to house prices — where most families hold most of their wealth — when mortgage rates are back to ‘normal’?

And what about all that inflation already ‘in the pipeline’? Energy, raw materials, rare metals — sooner or later, the ‘inputs’ must be passed along to final consumers. How can the Fed prevent it? What dial do they turn? What lever do they pull?

Soft landing?

We don’t know, but if Jerome Powell can pull this off, maybe he can broker a peace deal in the Ukraine, so that the two sides walk away with no hard feelings?

And maybe he can walk across the Potomac…and receive his Nobel Prize from God Himself?

Regards,

Bill Bonner,
For The Daily Reckoning Australia