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Are we out of monetary ammo?

Click? Is that the sound of the RBA gun firing blanks?

RBA
Source: Bloomberg

I don’t think it is but yesterday’s hold decision suggests Glenn Stevens and Co. may have one or two bullets left in the chamber. Are we at terminal velocity?

The more dovish of commentators suggested that terminal velocity for the RBA is a cash rate of 1.5% or even as low as 1%. However, yesterday’s statement, coupled with the fact a 2% cash rate seems a very high hurdle for the RBA to jump over, suggest terminal velocity looks to be 2%, with maybe 1.75% at the absolute worst-case scorched earth scenario as a Australia’s economy slows down.

Interestingly, the IMF downgraded the globe’s growth outlook down a notch overnight – the concern from the IMF is that consumption is going to remain subdued, which is not good news for China and ultimately not good for Australia.

A lack of global consumption also means business investment will remain dormant and, try as they might, central banks can’t force people to consume no matter how much cash they throw at the problem.

This is why the following line from the statement makes me think the next move lower in rates could mean terminal velocity: ‘Prices for key Australian exports have also been falling and therefore Australia's terms of trade are continuing to decline.’

No joke they have been declining – iron ore is off over 21% in two months. Coking coal is feeling the pinch of lower steel demand while the collapse in the oil price has been laid bare for all to see. Yet this was still not enough for the RBA to stimulate the economy.

What’s more - in the fast money trading before the RBA announcement, the ASX added 1.34% at the top of the market. This completely overlooked the second-biggest story of the day – mining and specifically iron ore plays are now hitting the wall.

The news from Atlas Iron was something I have long suggested was coming and I don’t believe it will be the last bad news on the wires. I have concerns for BC Iron, Mount Gibson and the junior play Gindalbie Metals as well. Some would also suggest Fortescue is in the same boat - its balance sheet is a major concern and there is a very strong case that FMG is now trading underwater. However, it has passed construction phase while the others have not, giving it some breathing room

The fact Atlas was producing an iron ferrous content of 55% to 58%, compared to the quoted price of 62% meant it was being offered a haircut of between US$10 to US$15 on the spot price. Its balance sheet was overleveraged and its half year numbers showed a huge net loss when the spot price was in the mid $50s to low $60s. Companies with the same profile as Atlas will be in the gun of investors looking to get out.

So where does that leave our Australian strategy?

First - the strategy of staying clear of mid-cap and junior miners has been the right one and one we are unlikely to change that view in 2015.

Second – I think the yield trade in Australian equities remains the right one – for now. The carrot for yield investors is still being laid out in the wording of the RBA’s statement: ‘Further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target.’

However, if we do see further signs that the RBA is at terminal velocity, this trade will plateau and in several instances retreat, prompting a change of tack.

Third – Europe and Japan remain our key markets globally. Unlike the RBA, the ECB and the Bank of Japan have the ability to keep loading bullets and pulling the trigger – neither look like they’ll be slowing down in 2015.

The DAX and the Nikkei have a diverse mix of equities with high-end manufacturing, services and capital goods. Even in a declining consumption world, demand for the goods and services offered from these markets are highly desirable and a falling EUR and JPY makes them appear cheap to global consumers.

There is definitely nervousness around the world. I think the investment path in 2015 is murky. However, the upside momentum has yet to be broken and, with underperformance in the bond markets still forcing funds into equities, we continue to suggest following the fund flows.

Our strategy has not changed (yet), but it is constantly under review. If we see the RBA hitting terminal velocity, this is likely to prompt a rethink of stocks we’ll be investing in on the ASX.

Ahead of the Australian open

We are calling the ASX 200 up 24 points to 5949, as the Chinese markets continue to power ahead. A May rate is now starting to be priced in and there was a slight recovery in iron ore. It will be a less volatile day than yesterday but we will likely see a few repositioning trades now we are clear of the RBA.

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