Typically, banks and energy companies enjoy a similar factor rotation in stock markets, marked as cyclicals.
Both benefit as the economic cycle enters the expansion phase, which is where we should be about now.
However, the last week has witnessed a startling divergence in this relationship. Banks have suddenly gone from cyclical heroes to late-cycle bust zeroes, while the energy war profiteers are tearing it up:
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Expect this to get much worse. The reason why is simple.
In the absence of regulatory action to kill the energy war-profiteering, the RBA is going to crush every other price in the economy to “make room” for it:
Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected. Global factors, including COVID-related disruptions to supply chains and the war in Ukraine, account for much of this increase in inflation. But domestic factors are playing a role too, with capacity constraints in some sectors and the tight labour market contributing to the upward pressure on prices. The floods earlier this year have also affected some prices.
Inflation is expected to increase further, but then decline back towards the 2–3 per cent range next year. Higher prices for electricity and gas and recent increases in petrol prices mean that, in the near term, inflation is likely to be higher than was expected a month ago. As the global supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today’s increase in interest rates will assist with the return of inflation to target over time.
However, even with the RBA crushing everything else, unless Albo’s cowards do something to sit on local energy prices, utility bills will continue to skyrocket all of next year because wholesale energy prices filter through contracts only slowly. The RBA cannot influence these prices.
If the underlying, globally set coal and gas prices remain the same as today then the forthcoming utility bill hikes with spillovers will add 0.5%-1% per quarter to CPI.
In short, the RBA will have to move interest rates much higher than it would normally and stay there much longer than the economy can handle.
This is a context in which the long-feared Aussie house price crash can burgeon and so banking stocks are suddenly getting belted.
In short, the equity market is beginning to price the risk that something will snap in the highly-indebted Australian economy in the near future. That thing is the banking system as profits are smashed by bad loans, falling collateral, and the inability to pass on full rate hikes leading to margin squeezes and rising funding costs.
Amusingly, credit markets are unmoved. They are still pricing runaway rate hikes deep into 2023. The energy shock makes this reasonable given the sticky CPI implications.
However, it is my bet that before too long the equity market will be proven right as banks keep falling and credit markets eventually follow as the war-profiteering recession we didn’t need to have lands hard in eastern states in a matter of months.