Have we just seen more proof that the era of central bank manipulation is nearing an end?
After nearly six years of seemingly non-stop meddling, it’s almost impossible to believe that could be true.
But what if it is?
We mentioned yesterday that things may have changed…that perhaps no more will ‘bad news be good news’.
Well, the evidence mounts…
Yesterday Bloomberg News reported:
‘Traders who placed record bets against the Australian dollar are ruing their timing, after the central bank signalled two years of interest-rate cuts are at an end and stepped back from efforts to talk down the currency.’
It’s probably a bit of a stretch to say central banks have completely stopped manipulating the market. Arguably the act of openly saying they won’t cut rates is itself manipulating the market.
Proof of that was in the reaction of the foreign exchange market. After sinking for more than three months, from 97.5 US cents to 87 US cents, the Aussie dollar gained more than two cents against the US dollar.
Not that the news did much for Aussie stocks. They fell for another day.
Better than Blue Chip Stocks
There’s no doubt it has been a bad time for stocks since the start of the year. The S&P/ASX 200 index is now down 5.3%.
But what may surprise you is how other areas of the market have performed in recent weeks.
Normally when the market dips you’ll see blue chip stocks hold up better relative to smaller stocks.
That’s because investors migrate towards supposedly ‘safer’ stocks. That doesn’t mean they’re completely safe. It just means they tend to fall less than smaller stocks.
But in recent weeks a funny thing has happened.
Supposedly safe stocks — as measured by the S&P/ASX 200 — have fallen 5.3%, and yet, some of the market’s riskiest stocks — as measured by the S&P/ASX Emerging Companies index have fallen a paltry 2.2%.
You can see the proof of that on the following chart. The blue line represents the blue chip stocks, and the yellow line represents the emerging companies stocks (small-caps):
But what’s just as interesting is the red line on the chart.
The red line has fallen 5.2% since the start of the year. That’s better than the performance of blue-chips.
What index does the red line represent? Mining stocks.
Interest Rate Cuts No More
We wrote a few weeks ago that we don’t like using relative performance when talking about returns. In our view a loss is a loss. The fact that one loss may be lower than another loss doesn’t impress us as an investor, and it shouldn’t impress you either.
If you’re paying for financial advice, you want that advisor to make you money, not lose you less money than someone else.
But when it comes to analysing the performance of one index against another, it’s perfectly fine to weigh up the relative returns.
In this instance, it’s mind-blowing that not only are small-cap stocks doing better than blue chip stocks, but mining stocks (the most hated stocks on the market) are doing better than blue chip stocks too.
So, why is that?
That’s simple. A big reason for the blue chip stock rally was the fact that interest rates were heading down. With lower interest rates, investors had to ditch savings accounts and plunge into the stock market to get a higher yield.
But if the Reserve Bank of Australia says it won’t cut interest rates any further, there’s a chance that you could see some interest rates rise — although not by much.
Even so, just a slightly higher yield on deposit rates could be enough to make dividend yields less attractive to investors. Unless companies can increase their dividend payments.
That’s by no means certain. Although based on our research there is still a fair amount of room for Aussie stocks to raise their payout ratios.
Dividend Rally Ends, Growth Rally Begins
The rush from dividend stocks into cash hasn’t really affected small-cap stocks. That’s because most small-cap stocks don’t pay a dividend.
So while investors have rushed to sell dividend stocks, most of the small-cap market has been left untouched.
Investors left small-cap stocks for dead in 2012 and 2013 as they searched for yield. So these stocks are still trading at bargain basement prices.
Since the end of 2010 the blue chip index is up 5.6%. Compare that to the mining index, which is down 36.7% and the emerging companies index, which is down 44.9%.
Now, that doesn’t automatically mean the low stocks will go up and the high stocks will fall. But it does suggest that if interest rates don’t fall further, investors will start looking at value growth plays.
In other words, stocks that haven’t yet gone up. That spells good news for growth stocks of all sizes — large-cap, mid-cap and small-cap. And it spells especially good news for one bunch of hated stocks; mining stocks.
It’s still too early to claim that central banks have left the market. But if you can trust them to leave interest rates where they are for the rest of the year, it could be a great time to back Aussie growth stocks for top returns in 2014.
Cheers,
Kris
