08 Jun

Follow the smart money

Interest rates are rising, inflation is high, and pink diamonds are performing strongly – the more things change the more they stay the same as the saying goes, with 2023 looking to be a carbon copy of 2022 when it comes to the major factors driving the market.

In this week’s market update, we look at a key share market indicator that highlights the dangers that exist in the market today, and should act as encouragement for investors to diversify some of their wealth.

We also look at the latest local news, most notably the interest rate hike delivered by the Reserve Bank of Australia (RBA) earlier this week, the challenges it poses, and why pink diamonds are an asset offering positive opportunities in this environment.

What do smart money investors know?

There have been no shortage of risk factors afflicting investors this year. Inflation remains at problematic levels all across the developed world, the war in Ukraine continues, with no end in sight, and the United States at one point looked like it was heading towards defaulting on more than USD $30 trillion in loans that it has taken out over the years.

On top of this, we’ve seen indicator after indicator point towards a looming recession, from a slowing housing market, to poor retail sales, to a persistent inversion of the yield curve, where short-term interest rates are higher than long-term interest rates.

Despite all of these risk factors, it hasn’t only been niche assets like pink diamonds that have continued to perform well, with traditional assets like the share market also showing good performance.

Indeed, the world’s largest equity market index, the S&P 500, is up by more than 12% for the year, with technology stocks leading the way. The ASX 200 in Australia is also up, though by a more modest amount.

There is a glaring problem though: the smart money doesn’t think the rally in equity prices will hold, and have been selling shares hand over fist for most of the last year.

This much is made clear in the chart below, which shows cumulative equity market flows from retail investors, index/ETF products, hedge funds, and institutions, with the latter dumping hundreds of billions of dollars of equity market holdings since May 2022.

Cumulative capital flows
From May 31, 2022, to May 31, 2023

A graph showing cumulative capital flows

S&P 500 performance (%)

Graph showing S&P 500 performance (%)

Source: S&P Global Market Intelligence.

This should serve as a major warning sign for everyday investors, as the most connected market participants are reducing their exposure to the share market.

The primary reason to do this would be some kind of expectation that we are in for another serious share market rout.

Assets like pink diamonds are a potential refuge in such a scenario, helping investors sidestep the potentials share market rout we may well be heading toward.

Rates keep rising – more to come?

While it was not the consensus call amongst market commentators, it was no great shock to see the Reserve Bank of Australia (RBA) increase interest rates again earlier this week.

The decision, which saw the local cash rate increase to 4.10%, represents the 12th interest rate hike seen in Australia since May 2022, with the RBA hiking rates by 4% (from a low of 0.10%) in just over one year.

It’s one of the sharpest paces of rate increases on record, with the RBA still obviously worried about persistently high inflation, with a monthly data series suggesting prices across the nation rose by 6.8% in the year to end April.

That’s far too high given the RBA prefer to see inflation in the 2-3% target range.

And given the recent surge in rental costs which will likely gather pace for some time, the small rebound in house prices in the last few months, and the still rising electricity bills, the RBA is obviously of the view that much more needs to be done to get inflation under control.

Don’t be surprised if rates continue to rise for a few months.

The impact will be as follows:

  • More pressure on mortgage holders, who will be forced to continue to cut back on non-discretionary spending.
  • Lower spending across the economy, hurting company profits and jobs.
  • A return to weakness in the housing market, with prices potentially set to fall again as we enter the second half of the year..

All of this spells trouble for traditional assets and should encourage investors to rotate at least some of their portfolio into genuinely scarce, alternative safe haven assets that can prosper through such a period.

Indeed, in many ways the trend that we see developing in Australia is aligned with the chart seen earlier in this update, focusing on institutional equity outflows.

For regular investors looking to follow the smart money, pink diamonds continue to offer a unique, and historically highly profitable way of minimising volatility, diversifying a portfolio, and generating wealth.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and we look forward to any questions or comments you may have.


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