Jump Aboard the Wall Street Express

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Buckle up for the US bull market to keep running in 2019.

US stocks are roaring!

But you wouldn’t know it taking your cue off the headline indices.

They’re treading water while the midterm election result remains unknown.

But the hard numbers coming out are stonking expectations. Remember that US companies are reporting their third-quarter earnings right now.

The Wall Street bean counters expected growth of 20%. That’s a high bar.

Three-quarters of the shares in the S&P 500 have released their numbers. The growth rate is currently 24.5%.

It’s one of the best quarters since 2010.

It’s highly plausible for US stocks to keep running from here.

America sets the tone for the world to follow, including Australia. We could be in for a profitable period shortly.

There’s another clue on that too…

Cast your mind back a few months. The mainstream press was preoccupied with the idea that the ‘yield curve’ would invert. This is when short-term interest rates rise above long-term interest rates.

Historically, a recession is a likely outcome after that happens. A lot of stories ran around this idea…and invoked a looming slowdown.

Here’s a thing you learn about the market when you stick around long enough. Whenever we all watch for something to happen…it doesn’t happen.

The yield curve did not invert. Admittedly, it got mighty close. It came within a whisker (18 basis points).

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However, it’s now actually widening. That puts off the immediate concern of an economic downturn, based on this criteria anyway. It should also make it more attractive for the US banks to lend.

We do have one thing to watch when it comes to the financial industry over there. It’s very important, though few will understand the implications…

The rule change that made the 2008 bear market worse

The Wall Street Journal reported back in October that a new rule is due to come in 2020 that will change how US banks account for their bad loans.

Currently, US banks don’t record a loss on a loan until they have evidence that it’s a problem. The regulators say this can leave soured borrowers unrecognised for too long.

In turn, this new rule means banks need to project future losses as soon as any loans come into existence, and investors have a clearer picture of their total risk.

It’s a bit obscure, but here’s the point.

The change could mean banks need to set aside more loan loss provisions and withdraw lending if the US economy gets into trouble.

That’s exactly the opposite effect of what you want to happen when the economy slows down. Banks need to INCREASE lending to get things moving again.

Now, let’s play out a bit of a scenario here. We come to 2020. US stocks are higher than they are now. The good times have defied all the bears and doomsters.

But underneath the party atmosphere, interest rates have risen and stressed more borrowers. More defaults start showing up for the banks.

This means they need to dip into their reserves to start covering this. And because of this new rule, they start getting nervous about making loans.

That means credit starts drying up exactly when there’s a lot of refinancing due in the corporate bond market. We could see some kind of credit crunch.

There’s a precedent for this. In November 2007, the Financial Accounting Standards Board (the same one in pushing the new rule above) introduced a strict rule on how US banks needed to account for their debts and ‘mark them to market’.

This pushed the banks’ balance sheets further into distress because the economy was collapsing all around them. That rule got repealed in March 2009 – which was where US stocks finally bottomed out. Coincidence?

Now, there’s no guarantee this new rule turns into a problem. US banks may succeed in having it squashed. Or the world sails on regardless.

But we’ll keep tracking this in Profit Watch. It’s always some obscure issue that can wipe out the share market when least expected.

It will never be whatever everyone is obsessing about openly. People prepare when that happens and it gets priced into the market.

This US banking change is something to watch for down the track. For now, the Wall Street express continues. Earnings are driving it. Buy the dips if you’re prepared to hold for a year.

Regards,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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