International Communique No. 310 – 12th October 2021
YOU SAID STAGFLATION?
Amid higher volatility last week, equity indices showed moderate gains. Oil & gas along with automotive performed well, while tech was dented by the rise in the US 10-year yield to 1.6%. On the whole, hesitation was in the air, spooked by higher inflation, just as the price of oil has reverted to its highest level since 2014. Other bugbears last week were the debt ceiling and the faltering US jobs market.
With OPEC unwilling to increase supply substantially and the US not planning to draw on its strategic reserves, energy prices have continue rising, rekindling fears of a surge in consumer prices.
Adding to that, only 194,000 jobs were created in the US during September versus the 500,000 expected, suggesting that economic growth may be cooling stateside and raising the question whether the Fed, part of whose mandate is full employment, might actually back off from tapering, i.e. the reduction of asset purchases.
However, the notion of more persistent inflation than expected dominated proceedings, is putting pressure on yields. The post-pandemic economic recovery is no longer in its breakneck phase, casting doubt on how it will proceed from here. The trending word now being ‘stagflation’, which is reminiscent of the 1970s. Such periods are favourable neither to fixed income nor to equities and therefore require a more defensive approach to investing.
The fate of the rally in banking stocks, which have already strongly performed this year, will depend mainly on long-term yields and how this will affect lending activity. The prospect of higher rates, evidenced by a steepening yield curve, would increase the net margin, i.e. the difference between the cost of deposits and the interest on new loans. US banking majors will report their third-quarter results starting this Wednesday. Earnings growth is expected to average 20% versus the prior-year period. In any case, they have significantly reduced their loan-loss reserves, which is already reflected in higher earnings per share and stock prices. One major challenge for banks is limiting the lost ground relative to other lenders in an environment whereby households are reluctant to take on debt. Sector multiples – including European banks – remain relatively affordable. For example, the price/earnings ratio is around 12x versus over 20X for the S&P 500.
If you have any questions please contact the office on (03) 9670 6070.