Economy, gold, oil, mines, banks

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Mikael Syding
16/05/2023 | 7 min read

Investing is very much about separating signals from noise, i.e. identifying which information is actually important for the future return of a stock.

Unfortunately, investors are constantly bombarded with unreasonable amounts of noise disguised as relevant signals. The signals, on the other hand, are few and vary over time in their significance. Even the signals are unfortunately mostly quite unreliable, but a fraction of the time they are still strong enough to provide relevant forecasts. However, the signals are hidden partly by the large irrelevant data flood, partly by the fact that they themselves are not significant about 90% of the time

So every day, amounts of economic statistics are published on important figures such as interest rates, inflation, savings rates, loan volumes, consumption and production, etc. Those data points are indeed central to the economy, but unfortunately lagging behind and therefore rarely useful for anything other than fine-tuning existing models of how the economy works. Every day you can also take part in so-called sentiment surveys, i.e. summaries of responses from e.g. purchasing managers in various sectors of the economy or credit officers at banks (those who decide which customers should be granted loans). Sentiment surveys belong to what is called "soft" data points, as opposed to the "hard" and concrete (but old) information about the actual economy. The soft information is what a select number of decision makers claim to think and plan to do, while the hard information is what they demonstrably did some time ago.

Money shows the way. The most important signals that can indicate the end of a boom and the transition to recession can be found in the financial sector. It is partly about interest rate curves, more specifically about first an inverted interest rate structure where long interest rates are lower than short interest rates, and then a return to a normal, positive curve. It is this return, reversion, that usually signals that the recession is near. In the current economic cycle, over the past year or so we have witnessed several inversions and subsequent reversions of the yield curve, as the US Fed has raised its key policy rate from zero to five percent. If you didn't already realize the negative signal value of quickly 5 percentage points higher interest rates in an economy with the largest mountains of debt in history, yield curve movements are a very reliable signal of economic decline. Both signs are connected, of course, because it is when more and more money goes to service loans, instead of investment and consumption, that the economy backs down and companies cut back on the workforce.

Another very useful indicator is the SLOOS survey among lenders (senior loan officer opinion survey). It shows how easy or difficult it is to get a loan from the bank, and at the same time it measures how big the demand for loans is from the banks' customers. When SLOOS shows that the banks are more restrained in lending, then the recession is rarely far away. And it's even worse when the customers don't even ask for a loan, because then the latter have such strained finances and are busy with existing interest costs and amortization that they don't even want to take out new loans to try to service the old ones, much less borrow for investments or consumption. When SLOOS indicates that there will be fewer loans in the future, then the economy will also soon grow less. It is mainly the difference between pushing the economy extra with new loans and strangling the economy by paying off loans that determines whether it is good or bad times. It is the financial system itself, where banks create money by issuing loans, that gives rise to the major swings in the economy. Therefore, the financial sector also provides the most reliable signals about future developments.

The yield curve puts pressure on banks' profitability and lending ability and willingness to lend, and therefore portends worse times. This spring we have seen some spectacular examples, such as Silicon Valley Bank, of how expensive it becomes for a bank when the return on loaned money falls below the cost of funding. SVB basically went bankrupt due to the inversion of the yield curve. There were other factors as well, of course, but the yield curve both controls and signals important events in the most important sector of all. This is of course also reflected in the bank index on the stock exchange.

It is often said that no bell rings at the top of the market, meaning that you cannot tell when the stock market has peaked. Falling bank shares are, however, a bit of such a bell. When banks fail due to lower volumes and profitability, then the problems for them are propagated to the rest of the economy. Less is invested, less is consumed, fewer are employed. A recession takes hold and helps clean out misinvestments and unnecessary excesses in the economy. Many companies are then finally forced to lay off the employees who were only needed if the upturn were to continue. That is where we are likely to be now in the business cycle.

Namely, it usually takes about 14 months from the first interest rate increases until the layoffs begin and unemployment increases. Now in May, these 14 months have passed and, almost perfectly synchronized, you are just starting to notice some weakness in the labor market. New jobs statistics are still positive, but revisions to previous months have been distinctly negative at the start of the year, and the latest unemployment figure stuck out a bit on the upside. Whether it was noise or a signal cannot be said yet, but the timing is in any case just right.

So, the fixed income market is signaling red, SLOOS agrees and banking stocks have rung the top bell. Furthermore, the stock market is as expensive (measured as Price/Sales) as it was at the peak of the epic bubble in March of 2000. On top of that, many policy rate hikes are still ongoing, which normally means that the biggest negative impulse to the economy is not felt until about a year from now . So it will get worse for quite a long time. The slowdown is already being felt in soft sentiment data and maybe, maybe eventually as I said also in the notoriously lagging job market. The recession that should help lower inflation is thus almost a fact. Due to the record high valuations, only beaten off the peak at December 2021-January 2022, one can also expect sharply falling stock prices in the coming year as the recession becomes more evident.

The market is unusually narrow this year, with the focus on a few large technology companies accounting for the entire rise. Microsoft and Apple seem to be almost on the way to becoming the entire stock exchange. The narrowness in itself is a sign that investors are looking for fewer companies that have a positive trend, the stocks that still "work". The question is really what do you dare to buy now? Should you stick to the top five, or should all stocks go down when the recession squeezes profits in the economy? Or will it be a more moderate and normal correction, so you can count on rotation between sectors rather than big withdrawals that sink all ships?

Microsoft Corp (in USD), five year weekly chart

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Source: Barchart. Note: Past performance is not a reliable indicator of future results.

Apple Inc (in USD), five-year weekly chart

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Source: Barchart. Note: Past performance is not a reliable indicator of future results.

Is it perhaps bargain buying day in real estate companies and banks already? I personally think that, for example, the large Nordic banks look far too cheap compared to the rest of the market. At the same time, we have not seen the effects of the yield curve and credit losses (not least from the real estate sector) in the banks' results. There may probably be some report disappointments in the future that keep the prices down despite the fact that the companies are attractively valued in the long term. And as far as real estate companies have already fallen, they tend to fall almost as much in the second part of the downturn, so I wouldn't buy a bargain in that sector just yet. The banks, on the other hand, are critical of the system and will both remain and have their natural market shares and make just as large annual profits again after a slump. If you want to keep your money in the stock market, I think Swedbank, Handelsbanken and Nordea could be good parking places.

Nordea Bank (in USD), five-year weekly chart

Source: Barchart. Note: Past performance is not a reliable indicator of future results.

Swedbank (in USD), five-year weekly chart

Source: Barchart. Note: Past performance is not a reliable indicator of future results.

However, I think most of the other companies in OMX will see both reduced profits and valuations - in a way that does not necessarily bounce back all the way up for several years. The valuation multiples simply became too high due to the prolonged zero interest rate policy. In this particular part of the economic cycle, I would therefore put myself as much outside the stock market as I get. For some it is completely outside, for others only half, and for some it may only affect which industries you choose to own.

In addition, we are in a special phase of a very long financial cycle where old excesses have led to deteriorating monetary value and more and more desperate politicians. Once the recession hits, new stimulus measures arrive like a letter in the mail. It is a bit paradoxical only when it usually dawns on the market how bad things actually are with the economy. Namely, the worst stock market crashes of the 2000s have occurred exactly at the time when interest rates were cut sharply, rather well timed starting around the first cut (when the central bankers finally see the slowdown in their lagging economic statistics).

Just then, it is real assets that hold up the best. This time, the focus may fall particularly strongly on the precious metals gold and silver. Gold also set a new price record in USD a few weeks ago, which is a signal that gold buyers have regained their confidence. The price of gold has in similar phases in the past quickly doubled and silver increased in price even more. If you can catch just a little bit of that ride before switching back to cheaper stocks, you can be really happy with your investment as an investor this cycle. Furthermore, there may be a secular opportunity in the entire mining sector, i.e. everything from gold and silver mines to companies with a focus on electrification, not least copper, but also more specific battery metals such as lithium, cobalt, nickel and more.

When you're talking about real assets, I inevitably think of oil and oil companies. They are as cheap as the banks despite a structural lack of oil. So I like to buy banks, gold, electrifying metals, uranium and oil, i.e. money and energy in various forms, rather than the rest of the economy, such as entertainment, consumption and software. In any case, I expect big moves both up and down as the market digests the coming year's signals, not to mention all the noise - not least stimulus measures and the US presidential election. First, however, I think stocks could fall significantly from today's levels, and gold could rise sharply. Then we'll see what the politicians can conjure.


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