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Capital 19 Catch-Up

Weekly Index Movement

S&P500 -0.2%

Nasdaq -1.3%

Aussie All Ords -3.3%

Last week was all about central banks and interest rate hikes.

In Australia, the RBA lifted rates by 0.25%, for the first time in 11 years and there are more raises coming. That first move to begin the tightening cycle upset equity investors and the Aussie market fell in response.

The major banks immediately announced they would be passing that rise on fully to mortgage holders.

Speaking of the banks, ANZ, NAB and Macquarie announced earnings last week.

ANZ (ASX:ANZ) reported a first-half profit of $3.5billion, up 10% on the previous half. But cash profits were $3.1billion, which is down 3% on the same period. It announced a dividend of 72 cents which is the same as the prior dividend. The trailing twelve-month dividend yield is therefore 5.5%.

NAB’s (ASX:NAB) cash profit was up 8.2% on the prior half to $3.5billion. They are maintaining their 68% cash payout ratio so the dividend this time is 73 cents versus 67 cents last half. This gives NAB a trailing twelve-month dividend yield of 4.4%.

Macquarie (MQG) announced second-half profits of $2.7billion which was up an impressive 31% on the first half result. The dividend was $3.50 per share for a 50% payout ratio. That takes the trailing twelve-month yield to 3.5% but franking here is only 40% as international income contributes 75% of total income. That $3.50 dividend was a nice increase of 29% on the prior $2.72

We just can’t get excited about Australian banks. 4%-5% yields and low growth. There are much better investments out there.

Switching back to the US and the Federal Reserve

The Fed increased rates by 50bps on Wednesday. That was widely predicted. But it was also widely predicted the Fed would increase by 75bps in June.

In the press conference, Powell said there are no plans to increase by 75bps, and stocks immediately added 3%.

Which was strange. Even though he took 75bps away, he can still do a serious of 50bps hikes.

Sure enough, the market realised this and stocks fell 3% on Thursday.

The market now expects the Fed to increase by 50bps in June, July and September and then increase by 25bps in November and December, bringing the year-end interest rate to 2.75-3.00%.

This is very much inline with Treasury Inflation Protected Securities at 3.2%.

The market thinks there might be one or two raises in 2023 but no more than that.

In summary – we had lots of volatility last week but the end result is the same as before. 3% rates by year-end.

Central Banks Wages Problem

Central banks are going to have a hard time fighting inflation.

For the most part, the cause of inflation is out of their control.

Oil has gone from $60 a barrel to the present $110 a barrel caused by the West’s sanctions on Russia. Russia used to supply Europe with oil but now Europe must get their oil from elsewhere.

It means Europe is now bidding on the same US and Middle East oil as the rest of the world was. More demand for the same product sends the price of that product higher.

High oil prices are here to stay.

Why don’t OPEC just increase oil production and bring the price down?

Because they want to make big profits.

Imagine you own an oil well. There are only so many barrels of oil in that well. You intend to sell them over time. Do you want to pump a lot more of that limited supply out now, to depress prices and help the world, or do you want to sell your oil for as much as you can for as long as you can?

So, no, OPEC will not be increasing supply by any significant volume. They want a high oil price and so high oil prices are here to stay for some time.

This is why we have been saying the Energy sector is our favourite right now. Even though stock prices are up, they are being priced as if this is just an oil spike and prices will return to the prior $60 a barrel. But we believe prices will remain high for a long time and energy companies will make big profits for years to come.

A high oil price increases inflation on its own. But it also increases the cost of transport for all goods. That increased transport cost is passed onto the consumer in the final price. Which is why you are seeing increased prices for all goods.

Central Banks cannot influence the price of oil, no matter how many rate rises they give us. I doubt consumers will alter their driving habits too much, so this higher oil price will act as a drag on spending and slow economies. This will help the central banks.

But there is another problem. Employment and wage growth.

In the US, employment is almost back to pre-Covid levels and likely to continue to improve as the JOLTs data last week showed there are presently enough jobs wanted to give every unemployed person two jobs.

Employers are having a hard time finding employees so they are bumping up wages to attract them.

On Friday, the US announced the economy added 428,000 new employees in April and that average wages had increased 6.4% year-over-year.

On one hand you have the Fed increasing interest rates to reduce spending capacity of the consumer to slow the economy, and on the other you have more and more people gainfully employed and wages increasing for them.

Australia has a similar problem with record unemployment and wages growing 2.3% y-o-y.

This is a real problem for central banks trying to slow inflation. We can expect more and more interest rate rises, so stocks sensitive to this (think technology and consumer discretionary) will continue to be sold until we see a significant slow down in inflation.

This is why we are seeing so much volatility in stock prices. The market can’t work out which side of the line we are on. Will Central banks be able to slow inflation enough by gradually increasing interest rates or will they go to far and slow economies too much? Or, can they even do anything about it anyway?

What Would Buffet Do?

What’s the number one rule of investing?

“Buy low, Sell high”

Most investors fail to follow this most basic of all investment rules. But Warren Buffet didn’t forget in Q1. His most active period of stock purchases in years took place during the weakest part of Q1

We are pretty sure he will take this opportunity to buy more, particularly now CNBC has run its “Markets in Turmoil” Special.

Markets in Turmoil

This is a new one for us. But we like it.

Charlie Bilello, founder and CEO of Compound Capital Advisors, tweeted on Friday that the S&P 500 has generated a positive one-year return each time CNBC has run a “Markets in Turmoil” special, the latest episode of which aired on Thursday.

His research shows that the S&P500 has had a 100% success rate, one year after CNBC run their “Markets in Turmoil” special.

We haven’t verified his research but it would make sense.

The media are an excellent source of contrarian buy signals. A contrarian buy signal is an expression of extreme negativity which tells us it is time to profit by going against the crowd. Or vice versa.

Classically, contrarian buy signals from the media come in the form of the magazine cover indicator. Whenever a financial news magazine moves an extreme market story out onto the cover (extremely bearish or bullish on the market overall, or a sector or company), it is time to bet the other way. In other words, time to do the opposite of what the magazine cover story is stating.

This is not to say that journalists are dumb, though many of them no doubt are. Instead, journalists and editors, above all, want to be read (that is their business model). So, they are very astute at sensing public sentiment, to determine what stories and themes will attract the most attention at any given moment. This talent gives them an extraordinary ability to express market negativity (to appeal to the crowd) around the best time to go long. And vice versa.

We are pretty sure Buffet is buying right now. Sentiment is certainly very bad. Looks like a great time to buy to us.

Last time, Buffet bought a lot of Apple (AAPL) and Chevron (CVX). This is your opportunity to do the same for your portfolio.

Warning

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.

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