Recent moves in key global markets are flashing signals to investors.
Traders and technical analysts who study markets often view price action as primary evidence. Traditionally this was a function of the old school of economics’ Efficient Markets Hypothesis. The rise of behavioural finance theories debunks much of the classical understanding of markets, but the esteem of price action is undiminished.
The newer understanding of markets is that prices for shares, bonds, and other assets, are a function of crowd behaviour. They are nothing more than a mass expression of opinion. They are no doubt sincere. After all, people and institutions are putting their money behind these opinions. The price of any traded good is therefore the product of crowd behaviour, an organic process.
Behavioural finance tells us decisions made under market pressure are not always economically rational. This means that despite the fact we use numbers to describe markets they are not mathematical, scientific or even logical. Price action is watched closely by market professionals because it is primary evidence of the aggregate opinion about a security at any given time. Studying the history of prices shows how market thinking evolves over time.
This is particularly important at the moment as a number of global markets are painting a consistent picture that has direct implications for investors.
Markets are finally convinced interest rates will rise
Interest rate traders have doubted central banks’ resolve to lift rates since the aftermath of the 2013 “taper tantrum”. The tantrum saw US 10 year bonds sell off from 1.64% to 3.01%. Then doubts emerged in early 2014. Over the next 2 years the yield fell again to reach an all-time low at 1.36% in 2016 as markets believed the Fed’s optimistic view of the economy was misconceived.
As it turned out the market was right and the Fed was wrong. In contrast today 10 year bond yields are on the rise, currently 2.45% from the September low at 2.01%. If they move through the highs at 2.65% the sell-off could accelerate and quickly climb above 3%. In further confirmation many other globally important bond markets are moving in sympathy.
The higher bond markets are signalling a better growth outlook. Higher economic growth gives central banks room to remove liquidity and lift interest rates. Importantly this scenario is echoed by commodity markets.
Growth up, havens down
Industrial commodities are moving higher. Oil is still well below cycle peaks, but is bumping against the ceiling of the two year trading range. The stand out performer is copper, up by more than 55% from the 2016 low. Nickel, lead and zinc are all in clear and sustained up trends. Coal is the real surprise. Global coal indices are up more than 200% from the 2016 trough. On the contrary gold is trending downward and is well off 2016 highs.
What does this mean for investors?
These market moves are pointing to a cycling forward of the global economy. They are primary evidence of a growing perception of a move into an expansionary phase for the globe, despite the general hand wringing of the (*ahem*) commentariat. (It’s arguably more sensible to follow the opinion of those on the field than on the sidelines).
Investors persuaded by the markets face a number of imperatives. Interest rate sensitive assets such as property, bonds and share market sectors like utilities will face pressure. Investment themes such as the chase for dividend yields will fall in popularity. A danger is a sharp move in bond markets could precipitate a stampede out of these areas. As grizzled old traders say “the first cut is the cheapest”.
Defensive stocks may also pall. Consumer staples and healthcare shares, once priced for their steady earnings, may fall behind as growth exposed companies gain more benefit from a general pick-up in economic activity.
Growth exposed investments could gain in favour. Many mining stocks are yet to reflect the moves in metals and energy prices. BHP’s leadership is regularly criticised. Yet three of their four main businesses are likely facing strong upgrades from analysts on the back of the upswing in coal, oil and copper. If iron ore joins the party BHP shares could melt up. And if may be the resource sectors (Materials and Energy) that finally propel the Australia 200 index through the 6,000 barrier.