Checking In on the 'Most Important Number in Finance'

Big news for Chinese stocks... Checking in on the 'most important number in finance'... This chart says rates could be going much higher... More of the same from the Fed... Powell tanks the market again...

Regular Digest readers know our colleague Steve Sjuggerud is incredibly bullish on China...

Despite the recent correction, he continues to believe many Chinese stocks will soar hundreds of percent over the next several years.

They also know that one of the biggest reasons has to do with a dramatic shift in the global investment markets.

In short, leading index provider MSCI recently decided to include domestic Chinese stocks – known as "A shares" – into its global stock market indexes for the first time. Because more than $12 trillion is currently benchmarked to MSCI indexes, this move means hundreds of billions of dollars will be forced to flow into these stocks over the next several years.

The plan officially kicked off in May. That's when MSCI added the first small tranche of A-shares – equal to just 2.5% of its long-term inclusion goal – to its Emerging Markets Index. It then added another 2.5% in August, bumping the total to 5% of its target.

This wasn't unexpected...

As Steve explained from the beginning, a shift of this magnitude can't happen overnight. Instead, MSCI would start slow, and if things went smoothly, gradually increase its weighting of A-shares over several years.

Well, if the firm's latest announcement is any indication, the first two rounds of inclusion may have gone even better than it originally anticipated. As news service Reuters reported last night...

MSCI said on [Tuesday] it will consider quadrupling the weighting of Chinese big-caps in its global benchmarks next year, a move that could bring in $66 billion in new foreign investment.

MSCI also proposed adding Chinese mid-caps and shares listed on Shenzhen's start-up board ChiNext, which would nearly double the number of mainland stocks in its indexes to roughly 430.

This is a big deal...

Despite ongoing "trade war" fears, one of the biggest drivers of Steve's bullish thesis is quietly playing out just as he said it would. Hundreds of billions of dollars will flow into these stocks in the years ahead, regardless of whatever else is going on in the markets.

But the story could soon get even better.

That's because MSCI may not be alone for long. You see, yesterday we also learned fellow global-index provider FTSE Russell could announce its own China A-share inclusion plan as soon as this week. From a separate Reuters report overnight...

After three years of saying "no," global index provider FTSE Russell is widely expected to welcome mainland Chinese shares into its major benchmarks this week, a move that could drive billions of foreign dollars into a market hit by a trade war.

A decision by FTSE Russell to include so-called A-shares into its widely-followed global benchmarks – expected in New York on Wednesday – would be another win for China's market regulator, after the historic inclusion of mainland stocks in MSCI Inc's share indexes in June.

Market participants say previous sticking points around capital controls and clearing and settlement are no longer issues, leading analysts to believe a "yes" decision is likely.

Elsewhere in the markets, the 'most important number in finance' is threatening to break out...

As you can see in the chart below, the yield (interest rate) on the 10-year U.S. Treasury note – which influences borrowing costs across the economy – has been moving higher for the past several weeks. It's now just shy of a seven-year high of 3.109% set back in May...

Of course, we can't know in advance if a breakout will occur at this time. As we've noted several times in recent months, "dumb money" speculators have been betting on higher yields like never before. If anything, history suggests lower yields are far more likely from here.

However, as we often say, the markets offer no guarantees. This sentiment extreme could grow even more extreme before it finally reverses.

Rates could continue to move higher in the meantime.

Our colleagues Ben Morris and Drew McConnell agree...

In fact, as they noted to their DailyWealth Trader subscribers yesterday, they believe a breakout above May's high could lead to significantly higher rates in a hurry...

If 10-year yields break through [to a new high above 3.2%], it will complete a powerful trading pattern called a "double bottom." Here's how it works...

In the chart below, you can see that yields fell to 1.39% in July 2012 (A). They rallied to 3.03% in December 2013 (B). Then they fell to almost exactly the same level – 1.36% – in July 2016 (C).

The two lows formed the base of our double-bottom pattern. Now, yields have rallied back to and slightly above their previous highs (D). This morning, the 10-year Treasury trades with a yield of 3.10%.

We've seen false breakouts before, like the one you can see on the chart this past April. But if yields continue higher here, the double-bottom pattern will be confirmed.

As they explained, this pattern suggests rates could move sharply higher...

Once confirmed, it projects a likely "yield target" of more than 4.5%.

At these levels, rates would likely begin weighing on stocks. After all, if investors can earn an adequate return in government-guaranteed Treasurys, riskier stocks become far less attractive on a relative basis. And as Porter noted on Friday, 10-year rates in excess of 4% would almost certainly begin to wreak havoc on the corporate bond market.

To be clear, this is no reason to panic. This pattern has not yet been confirmed. And even if it eventually is, yields won't move higher overnight.

Stay tuned... We'll be watching this closely.

Finally, speaking of interest rates, the Federal Reserve wrapped up its September policy meeting this afternoon...

As expected, the Fed voted unanimously to raise its short-term Federal Funds rate another 0.25%, to a range of 2.0%-2.25%. It also reaffirmed its expectation to raise rates one more time this year, and at least three more times in 2019.

While the Fed's announcement offered no surprises, the market was once again unimpressed with new Fed Chair Jerome Powell's post-meeting press conference.

Powell was generally optimistic about the economy, and said the Fed remains on track to gradually raise rates as planned. But no matter... As we saw following each of the last two rate hike announcements, stocks initially rallied only to close sharply lower following Powell's remarks.

New 52-week highs (as of 9/25/18): Fidelity Select Medical Technology and Devices Portfolio (FSMEX), ETFMG Prime Mobile Payments Fund (IPAY), Intuitive Surgical (ISRG), Koninklijke Philips (PHG), T-Mobile (TMUS), Vale (VALE), and Viper Energy Partners (VNOM).

In today's mailbag, a "patient" subscriber weighs in on the boom and bust commodities markets. What do you think? Let us know at feedback@stansberryresearch.com.

"I agree with the analysis of Commodities/Natural Resources in your Sept 24 Digest. As part of a 'balanced' portfolio I have held a small position in one of the larger mutual funds in this sector since 1994 (never more than 4% of my portfolio). It tanked over 40% in 2008, and is just now starting to approach its peak value before the crash (i.e. my account's value is still below where it was 10 years ago, but it's almost at that number and I expect it will surpass it soon.)

"In spite of this ten year hiatus, performance since I have owned it for nearly 25 years is average annual return of nearly 9% (there were some great years pre-2008). These past ten years I have been reinvesting annual dividends and capital gains at much lower per share prices (so I hold many more shares than in 2008). It's begun moving up dramatically in the past 18 months and I expect the pendulum to continue swinging in the new direction (higher prices) over the coming years.

"I know most people wouldn't have the patience, but one reason I hung on through the past decade was just to use the fund as a barometer for possible pending inflation and signs of economic growth (or continued recession). Seems to be working, and I may finally have a rich harvest coming!" – Paid-up subscriber Mark N.

Regards,

Justin Brill Baltimore, Maryland September 26, 2018