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Santa in a black SUV; Is the Fed's independence challenged?

Peter Warnes  |  02 Dec 2016Text size  Decrease  Increase  |  

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Those investors extrapolating higher iron ore prices from current levels are playing a dangerous game, Morningstar's Peter Warnes.

 

Did Santa leave his North Pole base a month early? Did he disguise himself in a dark blue suit, a red tie and red baseball cap? Were his eight loyal reindeers replaced by black, window-tinted SUVs?

Did he alter his welcoming greeting from "Ho, Ho, Ho" to hand claps and thumbs up? Has his traditional December stock-market rally come a month early? Possibly.

A new Santa Claus and his promises are behind November's strong stock-market rally. Old Santa Claus is humble, reliable and usually delivers, with parents his loyal helpers.

New Santa Claus is flamboyant, volatile and untested. Are investors opening presents early (taking profits) and putting money aside for some bargains in January and February?

The November surge in the Australian market was led by the resources sector, driven by the surprising strength in commodity prices, particularly iron ore and metallurgical or coking coal.

Copper and thermal coal also helped, with the latter coming back to earth as Chinese authorities relaxed the earlier 276-day production limitation.

Heavily index weighted banks also participated as fears of more onerous regulatory requirements and associated capital raisings abated.

As is usually the case in the Australian market, the banks have an undue influence, and when resources join in, the direction is generally assured.

It is unlikely the rally in bank shares can continue indefinitely as credit growth is subdued, bad debts are increasing and dividend payout ratios are under pressure, and commodity prices are volatile and can quickly retrace.

The props to the November rally may no longer drive markets higher. At current levels, the iron ore price appears vulnerable.

The rise and rise of the iron ore price over the last six months caught most by surprise. In early January, iron ore fines 62 per cent Fe spot (CFR Tianjin) traded below US$40 per dry metric ton. On 28 November, just above US$80. Few, if any, saw this doubling.

After a move to US$50 in March, the commodity traded in a US$50-US$60 band until late October. Then someone lit the after-burners, propelling the price above US$80.

While the Chinese stimulus programs in the first quarter of 2016 were responsible for the move from US$40 to US$50, it appears a significant increase in speculative interest has been responsible for the move from US$60.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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