Markets taking the optimistic view on everything from the Budget to Japan

The local market delivered a positive day on the back of reflation trade in resource sectors. This saw global buying at the open and then had a "choppy" trade sideways for the rest of the day. The local market keeps moving on below-average turnover, as sentiment remains weak on up and down days. We are in the ninth consecutive week without a single day’s turnover above $8 billion. We were seeing clear signs of tax-loss selling in underperformers while bargain hunters were jumping on beaten-up stocks as the tax-loss selling pressure comes off. 

The RBA expects inflation, but wait for it: there won’t be much and it won’t last. What they really meant to say was that they cannot do much more, so they hope it isn’t much and it doesn’t last. James Hardie (ASX: JHX) joined the band of corporates seeing costs rising but RBA still can’t see it. Energy and miners were the best on reflation and rising bond yields while utilities and property were the worst sectors. Gold stocks continued to climb as spot gold in A$ moved above A$2400 before fading back on AUD/USD strength. 

Recent data points out of India, Japan and Italy show inflation recovery, while the Japanese economic ponzi scheme delivered a worse than expected decline in GDP. The Japanese market is up on an expectation of more stimulus. Its unique economic experiment worked when the US and European Union were remotely capitalism driven. But the EU has become another Japanese-type economic experiment while the US is stuck with artificially low rates despite real economy running hot on too much stimulus. 

The US Fed’s QE purchases are jammed up early in the month to buffer inflation-related data and then it runs out of puff at the back end of the month. That generally allows bond yields to rise and equities to underperform. Bond yields are climbing and USD is falling. We are heading option/vix expiry at the end of the week. Expect volatility to pick up.

The irony of the Australia federal budget is not lost on bankers and rating agencies. Australia has delivered the biggest spending budget with debt shooting the lights out and no plan to pay it off but markets have almost completely ignored it. We are heading to a Sep/Oct election and the borders will be opening in Nov/Dec. Government will do substantial pork barreling in the next 4-5 months. Taxes and rates will go up from 2022 and government will start to cut services through ramped up entry standards. The structural problems pre pandemic are worse now but we have historical high debt on top. The budget is an unfunded dream that will unravel as quickly as the election is over. The reality of higher taxes and deflating asset bubbles are what is facing the economy over the next few years. Lazy election budget has delivered a short term upgrade at the cost of long term downgrade.

The main data points of the last 24 hours

Wholesale prices in India jumped 10.49% year-on-year in April of 2021, the highest rate since May of 2010 and well above market forecasts of 9.05%. It compares with a 1.57% fall in April last year when the coronavirus pandemic weighed on demand and prices. The biggest increase came from the cost of fuel and power (20.94% vs 10.25% in March), followed by primary articles (10.16% vs 6.4%), namely food (4.92% vs 3.24%), of which fruits (27.43%); and manufactured products (9.01% vs 7.34%), namely vegetables and animal oils and fat (43.28%). We’ve got inflation picking up in global manufacturing and outsourcing hubs like China, India and Japan etc. US input costs are going to keep going higher. US inflation does not look transitory!

The annual inflation rate in Italy increased to 1.1% in April of 2021 from 0.8% in the previous month, in line with preliminary estimates. It was the highest inflation since April of 2019, mainly due to a faster rise in prices of energy (9.8% vs 0.4%) due to both regulated (16.8% vs -2.2%) and non-regulated energy products (6.6% vs 1.7%). On the other hand, cost fell for unprocessed food (-0.3% vs 1%) and services related to transport (-0.7% vs 2.2%). Both the annual core inflation rate, which excludes energy and unprocessed food, and inflation excluding only energy slowed to 0.3% from 0.8% in the previous month. On a monthly basis, consumer prices went up 0.4%, following a 0.3% gain in March. Even Italy has inflation on the bounce despite being one of the biggest basket case economies in the EU.

The NAHB housing market index in the US stood at 83 in May 2021, unchanged from the previous month and in line with market expectations. The current single-family sub-index was flat at 88 and the gauge for home sales over the next six months edged higher to 81 from 80 in April. On the other hand, the prospective buyers sub-index declined to 73 from 74. Rising rates are delivering weaker demand while house prices are above pre-dot.com and pre GFC peaks.

The Japanese economy shrank 1.3% on quarter in Q1 2021, compared with market estimates of a 1.2% fall and after a 2.8% growth in the previous period, a preliminary reading showed. This was the first contraction since Q2 2020, amid a resurgence of COVID-19 cases and slow vaccine rollouts. Private consumption fell for the first time in three quarters (-1.4% vs 2.2% in Q4), government spending dropped for the first time in a year (-1.8% vs 1.8), and public investment declined for the first time in seven quarters (-1.1% vs 1.1%). Also, capital expenditure shrank 1.4%, swinging from a 4.3% growth in Q4. At the same time, net external demand subtracted 0.2%age points from growth as exports rose 2.3% while imports grew at a faster 4%. On an annualized basis, the economy contracted 5.1% in Q1, worse than consensus of a 4.6% drop and reversing from an 11.6% expansion in Q4. Japanese economy is declining faster than expected while inflation is raising costs. The inevitable Ponzi nature of the economy means it is a matter of time before BOJ adds more fuel to the inflation fire through more stimulus.

It is going to take an extremely tricky dance between fiscal and monetary policy to not move a hot inflation cycle into a hyperinflation cycle. Fiscal policy needs to keep printing to keep the majority of the economy funded while monetary policy needs to absorb the excess bond supply. This all needs to happen without triggering substantial USD debasement and market panic. We may be at the end of the “Central Bank Put” cycle as the US Fed may not want to risk hyperinflation hitting the economy to save the markets. Aussie Gold Miners are offering inflation/safety hedge with currency and sovereign protection from relative value territory.

Comments on the US market close

The US market started weak on Japanese/Chinese data and finished negative despite usual late recovery. The late pump was able to get the RUSSELL into positive territory while NASDAQ remains the laggard in reflation at the reopening. RUSSELL +0.11%, DOW -0.16%, S&P -0.25% and NASDAQ -0.38%. Yields and commodities are climbing while the USD is sliding. For a change, the AUDUSD is also slightly weaker as China effects kick in. Energy and Banks lead the sectors while Utilities and Tech were the laggards. Gold was by far the best sub-sector and Aussie gold miners are looking at A$2,400 price this morning. Micheal Burry of “Big Short” is taking on Cathy Wood of “Ark Investment” by shorting Tesla...and I am with him on this cycle. Disclaimer...I love the movie too...get ready for real-life sequel. Transitory or not, costs are going up with commodities while USD is falling. Ignoring reality isn’t a good strategy. Time to get some gold exposure and bear ETF protection. Central banks are burning balance sheets to hold asset bubbles and it’s driving inflation higher. Japan PPI is popping like China while China is moving aggressively to counter asset bubble risk. What could go wrong? History suggests caution.

Full SUNSET STRIP report with end of day market stats are on the attached link.

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