Capital 19 Catch-Up

Weekly Index Movement

Aussie All Ords-1.2%

US banking fears reared up again last week with some crazy moves happening in regional banks.

PacWest (PACW) was down 51% on Thursday and then up 82% on Friday.

There really is nothing to look at here.

There are presently 4158 banks registered in the US. So far 3 have failed.

If I told you about an industry where 0.7% of companies gone into liquidation in 2023 would you think there was something wrong with the industry?

Add in the fact the US Fed has gone on the most aggressive interest rate raising program ever, the outcome of which is uncertain, and you can see there is no reason for fear.

In fact, the banking sector is improving. Far from customers pulling money out, in the past week, deposits have INCREASED at regional banks

You can see what happened in the graphic above. For two weeks in March, customers pulled money out. But since then it is business as usual.

In fact, it is business better than usual as small banks have written more loans in the last week than any other point since 2021.

And, the amount of Treasury Bonds the banks deposited with the Fed in exchange for cash has been reducing showing banks are not experiencing liquidity issues.

So let’s move past the bank headlines and see what is really happening.

US company earnings continue to come in strong with 79% of reports beating expectations.

Apple reported last week and was able to turn in an impressive quarter with revenues 2% above estimates thanks to a 5% iPhone beat, a 6% EPS beat, and a new buyback program equal to 3.4% of market cap. To put that buyback in perspective – it is larger than the total market cap of 420 S&P500 members.

I like buybacks. They are a way of rewarding shareholders rather than dividends.

The problem for me with dividends is they get taxed as income so I lose some to the ATO, even after my franking credits. But buybacks have no tax implication for me until I sell my shares, which might be never for a company like Apple.

To understand a buyback, consider a company that has 10 shares on issue. You own one of those shares, so your share is worth 1/10th of the company value.

If that company uses its profits to buyback shares, it might buy, say 2 shares from other holders. Those 2 shares get written off the register so now there are only 8 shares remaining and your one share is now worth 1/8th of the company value.

Effectively your share has gone up in value but you don’t have a tax event so no tax to pay.

The Apple buyback program is for $90billion. That is 3.4% of the entire market-cap. If Apple completes this in the next twelve months, then you can assume the share price should increase by that 3.4%, due to the buyback alone.

If Apple had paid that $90billion out as a dividend, the share price would likely have fallen by 3.4% (that’s normally what happens) and I would have received a bill from the ATO.

So buybacks are a good thing and for some people (like me) are more tax effective than dividends.

Company profits are doing well, S&P earnings are likely to come in around $52.70 which puts the index on a 19.6PE. Not cheap, but not excessive either.

Forecasts are for improvements each quarter this year and for a record new all-time high earnings to happen in Q4 of 2023.

The problem is what the market expects and what the Fed is saying are two different things.

The market gives only a 0.1% chance that rates are at the same level as today, come the end of the year. The biggest odds are for 3 rate cuts before the end of the year.

But the Fed tells a very different story.

At their meeting last week, the Fed increased rates by 25bps to 5.00-5.25%

During the press conference, Powell had this to say about rate cuts this year (assuming the economy progresses as per the FOMC forecast)

“It would not be appropriate to cut rates and we won’t cut rates”

The funny thing about this statement was the market took it as confirmation rate cuts are coming. To understand how, you have to look at his primer – assuming the economy progresses as per the FOMC forecast.

The market is convinced the Fed has the forecast wrong (that could be fair as the Fed record is not great) and Powell opened the door to difference scenarios by saying the no rate cuts statement is dependent on his forecast.

I just can’t see where rate cuts will come from. I can’t see what the market is looking at to think the cycle is over. In fact, I’m not even convinced this is the top. There is a good chance they have to increase rates again before this is over.

The problem is the labour market.

Powell himself admits this is the issue. He sees the labour markets as “extraordinarily tight” and sees “much excess demand” despite “some signs that supply and demand in the labor market are coming back into better balance”. Every time Powell talked about how strong labor markets are, stocks legged lower.

Then on Friday we had employment numbers. Headline came in at +253,000 jobs created in April, above the +180,000 expected. But then February and March were revised down. Despite the beat and the adjustments, the story is, the labour market is not weakening. It has been stable all year. Even though Powell has tried to change this.

Unemployment actually fell to 3.4%. This is the lowest for 70 years.

The big problem (for Powell) is average hourly wages were up +4.4% from a year ago. This is lower than the +5.9% high of March 2022, but not by much.

Powell’s target is 2% inflation. He has said 3% wage growth is consistent with 2% inflation. 4.4% wage inflation is therefore above his target. Powell cannot beat inflation until he beats wage growth. Just what that will take – I don’t know. He has just embarked on the most aggressive program ever and it has not worked. He only really has one tool, so rather than seeing 3 rate cuts this year, I think it is more likely we see 3 more rate rises.

Time will tell if the wall street analysts get this correct or this writer from his desk in Sydney.

Next week we will get inflation numbers out on Wednesday. Core is expected to rise +5.5% over last year with a monthly increase of +0.4%. If this happens, it gives me more conviction my call of further rate rises will be correct.

On the topic of rate rises, Lowe surprised everyone in Australia last week when he added another 25bps. Well, everyone except me. Quite why they thought he would stay put is ridiculous.

Australian rates are now 3.85%. My prediction is they go to 5%+

Australian inflation is presently 7%.

Let’s compare the two markets. US inflation is 5.5% and their rates were 4.75%. They deemed this too low to conquer inflation so they raised rates to 5.0%.

Australian inflation is worse at 7% and our rates are less restrictive at 3.6% and the market thought that was enough?

A general rule of thumb is rates need to be higher than inflation to bring down inflation. You can see Australia has a long way to go to achieve this. Mark my words – there will be more rate rises in Australia.

Yes, you will hear lots of commentators saying this will cause pain to the low income sector. But guess what, to control inflation you have to create pain to stop people spending. That is the idea. If they do not experience any pain they will continue to spend and that will keep inflation high. There must be pain now for the long term good.

Of course, our Labor government won’t like this and will cave to Union pressure to raise low income wages and inflation will stay stubbornly high.

It is a mess and I don’t know how it ends. Except with a longer period of pain and for more people than would otherwise have been the case had the RBA done the right thing and pushed rates quicker and Labor done the right thing and not hand out more money.

For Australian investments, it bifurcates the market. The banks that everyone loves to hold for their very average dividends will struggle. The mining sector should continue to do well because their income comes from outside Australia.

I’ve been struggling to decide where to put money to work for the past month. I’ve now realised why. I can’t find an area with good growth potential. That’s because there aren’t any. Yes, individual stocks will perform, a few always do. But the easy money is gone. It’s going to be hard for the rest of this year.

Unless I am wrong and the market has it right. If that is the case, then large-cap growth is the place to be


Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.