As interest rates rise, so does the importance of stock picking. We’ve been making money on Blue Chip turnarounds, which includes AGL Energy (AGL), up 56% in six months (you read that right). It’s just over a year since Seven Group (ASX:SVW) took control of Boral (BLD) and renewed management focus on Australia so far returned 27%. Fellow building products group James Hardie (JHX) has returned 37% in 12 months and 13% just on the recent result. Then there is repair specialist Bapcor (BAP), which has returned 17% since June.

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The recent results from the banks, Comm Bank (CBA) and National Australia Bank (NAB) are encouraging, vindicating our positive rating on the sector, which has experienced a recovery. On the other hand, there is increasing divergence within Australia’s bank cartel.

ASX MINING STOCKS

On the resources side, this week in our Small Cap focused Under the Radar Report we highlight the risk to the copper price in the debt-ridden Chinese property sector. Although the copper price affects BHP Group (BHP) in particular, copper isn’t known as a bellwether metal for nothing.

The forces driving copper are driving most other commodities. In both these super sectors – financial and mining – stock picking is now more important than ever. Investing successfully in Blue Chips involves understanding the big picture – the global and domestic economies. These big companies are the economy!

BLUE CHIP VALUE TAKEOUT

The big end of town (the bond market) is effectively saying: keep your powder dry and prepare for opportunities to buy stocks on the cheap. Certainly, after a period of time where you could literally afford to relax amid relative calm, we are now at the point where you cannot afford to be asleep at the wheel. You need to pay attention to company financials this reporting season and what they’re saying about the future. This is where our team of analysts comes in. We are working out those companies that are passing on cost increases and those that aren’t; those that have the flexibility to make deals; and those that don’t. Subscribe Today.

We have been positive on banks for a while, but at some stage, the deterioration in credit quality should accelerate, albeit more for some banks than others. On the resources side, the Chinese property risk is bubbling away. Now is not the time to be selling. The risk of a hard landing (higher unemployment, negative growth) that was baked into expectations last October is now much more remote. The bond market is saying that it expects more economic pain to come, but as we are seeing, it’s on a company-by-company basis. Stock picking is the key.

As I said in our previous issue, domestic Australian stocks look to be good value and any market sell-off provides an opportunity. Look to accumulate the stocks listed above when this happens. Follow our recommendations. The big opportunities in this market are in Small Caps, which is why some of our tips are spiking at 50% and more. It’s not a coincidence that there are so many takeovers in our Small Cap stocks, which are the real deal (earnings-wise) and cheap.

ECONOMIC ANALYSIS

The big move this week in the markets is the rising US10-year Treasury bond yield, which has gone through 4.25% for the first time in the best part of 15 years.

The 10-year Australian Government bond yield is at almost this same level, highlighting the similarity of our two economies. This explains why the stock market has been gyrating up and down. It also means that there will be opportunities to buy and sell stocks.

WHY INTEREST RATES SHOULD STAY HIGHER FOR LONGER

There is a big contradiction at the heart of US and Australian economic policy. Our government’s 10-year bond rates are 4.25%, yet our inflation targets are 2% (in the case of the US Fed Reserve) and 2-3% (RBA).

If your inflation target is 2%, you need to add onto this real (inflation adjusted) economic (gross domestic product) growth consistent with price stability, which historically has been 1.5%.

Hence you are forecasting 3.5% growth for the foreseeable future. This is in effect your neutral overnight cash rate and 10-year bond rate for a steady state situation.

Hence The fact that the 10 year bond yield 4.25% is telling US Federal Reserve chair Jerome Powell and incoming RBA governor (currently deputy) Michele Bullock that monetary policy is still too loose, meaning official cash rates are still too low, or at least should be held at current rates for longer, with the Federal Reserve Overnight rate at 5.25-5.50%; Australia’s overnight cash rate is even lower at 4.10%.

Yes, inflation might have peaked. US inflation has slowed from roughly 10% a year in the first half of 2022 to about 3%, but the Federal Reserve’s comments this month indicated that they viewed inflation as sticky, with “upside risks” possibly requiring further interest rate rises aka tightening. I’m sure Jerome Powell and Michelle Bullock are watching bond yields very closely.

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