A Hail Mary and Hallelujah for this ASX Sector

ASX in 2020
Two Big Factors to Impact the ASX in 2020: Big Miners and Big Banks

I guess the US can drop the pretense about bringing democracy to Iraq now.

Their parliament just voted the removal of US troops, only to see it rejected in the harshest way possible.

The Wall Street Journal says the Trump administration is threatening to cut Iraq from its sovereign account at the New York Fed.

This is where Iraq keeps the US dollar revenue it receives from its oil sales.

Nearly 90% of Iraqi government revenue is from oil exports.

Any US move to block its account would turn the country toward complete anarchy in short order.

It’s not hard to see why countries like Russia and China want out of the current US dollar global reserve system…

The global trading system is permanently hostage to US foreign policy.

The US doesn’t want its troops out of Iraq. Most likely they’ll be there permanently.

The US is still in Germany and Japan, despite the fact that the Second World War ended in 1945.

They’ll have been in Afghanistan for two decades in short order, too.

How can this be?

The US is the only country in the world that can run an enormous balance of payments deficit and not cause a credit crisis in its domestic economy.

An economist called Michael Hudson says the deficit is almost entirely due to the vast US military spending.

Foreign countries are then obliged to recycle these dollars back to the US government via US Treasury sales and fund its gargantuan deficit.

Australia has no such luxury in this regard. When we borrow overseas, we have to pay it back.

That means we need to produce real goods and services to generate the necessary export income.

Here’s a taste of this kind of dynamic in action.

Aussie banks: the weak link exposed

The Aussie banks are currently borrowing big bucks in the UK and US.

The Australian Financial Review (AFR) says the Big Four have sold $13.8 billion in bonds to start the year.

They need this money to ‘fund’ their lending, which, in their case, is mostly mortgages.

International borrowing is all good if it’s used to fund productive businesses that generate future income stream.

Unfortunately for Australia, buying and selling houses to each other doesn’t produce exports.

That can be a dangerous dynamic to put in motion.

The banks always run the risk of not being able to borrow overseas, or at a competitive rate, if foreign lenders turn against us for whatever reason.

That’s why you and I should say three Hallelujahs and a Hail Mary for the massive rally in iron ore currently.

This is helping Australia run a trade surplus and bolster the federal government’s fiscal position. It means Australia is less of a credit risk.

That, in turn, is keeping interest rates low.

This current bout of borrowing from the banks is at the lowest rate since the global financial crisis, according to the AFR.

This looks bullish for the ASX, as I have been forecasting lately.

The poor returns from the banks was one thing that suppressed the index last year.

A lower cost of funds helps their net interest margin and therefore their earnings.

That’s not all…

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Twin engines to fire ASX

The ASX could lift substantially if we see genuine credit growth as well, thanks to a resurgent property market.

That would mean the banks and miners could fire at the same time. Iron ore is still over US$90 a tonne. This is pouring revenue into BHP and Rio Tinto.

The chief investment officer of super behemoth Hostplus must be thinking along the same lines and isn’t holding back saying so either.

He’s quoted in The Australian saying that shares are the only game in town because bonds and term deposits give you nothing…

‘[Stock] prices are sky high, company valuations are sky high without increased earnings. This tells you that people are prepared to pay for whatever dividend stream they can get. It’s a search for yield.

There will be a correction and we will get volatility, but very quickly people will realise there’s no alternative.

His base case appears to be that technology has killed inflation and therefore interest rate rises.

That kind of thing is right until it isn’t (and why I keep saying to watch oil to upset this line of thinking).

However, while oil remains subdued, the stock market remains your best shot at making money.

If the economy gets better, it will show up in improved earnings.

If it doesn’t, the pressure will come down on the RBA to implement QE and juice things up using monetary stimulus.

Be bullish.


Callum Newman Signature

Callum Newman,
Editor, Profit Watch