Market Pulse
Friday, October 11, 2024
Welcome to this week's Market Pulse, your 5-minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.
Our three stories this week:
1. Charged Up: Rio Tinto Acquires Arcadium
2. Getting Thrifty: European Savers Stock Up
3. Expect the Unexpected? The Surprising US Economy
It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.
On Wednesday, Rio Tinto, the world’s second-largest mining company, announced that it will purchase Arcadium Lithium in a deal worth nearly $7 billion. The deal makes Rio Tinto the world’s third-largest lithium producer thanks to Arcadium’s portfolio of mines in Argentina, China, Canada and Australia.
Lithium demand has soared in recent years owing to robust demand from the electric vehicle industry, where the element is used to make lithium-ion batteries. According to forecasts from the International Energy Agency, global demand is expected to climb eightfold by 2040, mostly thanks to EVs and other users of renewable batteries in the global energy transition.
Despite these trends, a global supply glut means that lithium prices have fallen dramatically over the past year. For Rio Tinto, that adds up to a potentially lucrative acquisition. Thanks to depressed lithium prices, Arcadium shares have fallen by more than half since the start of the year, below industry peers. Prior to news of the acquisition talks, Arcadium was trading at an enterprise value to EBITDA ratio of 13x, compared with 24x for industry leader Albemarle.
We hold Rio Tinto in Flagship thanks to the company’s disciplined capital allocation and focus on organic growth. Moreover, Rio Tinto holds several particularly high-quality assets when compared with competitors, including the Oyu Tolgoi mine in Mongolia and the Simandou mine in Guinea.
When combined with Rio Tinto’s existing strengths, this acquisition will reinforce the company’s potential for long-term growth, a factor not fully appreciated by the firm’s stock price. Currently, Rio Tinto trades at an EV-EBITDA ratio of 5.7x, compared with 6.4x for competitor BHP.
Given Rio Tinto’s effective management, Arcadium’s current valuation, and lithium’s long-term potential, we believe that this acquisition will be particularly accretive for investors. Further, the deal could help showcase Rio Tinto’s growth potential to the market, which might result in a boost to the firm’s valuation.
Saving some extra cash for a rainy day is often thought of as virtuous behaviour. But right now, Europe might be experiencing too much of a good thing.
Data released by Eurostat last week indicated that the household savings rate in the EU climbed to 15.7% in the second quarter of this year. That’s the highest level recorded in nearly three years and sits well above the pre-Covid average, which hovered between 12-13%. In the UK, the savings rate climbed to 10%, also a multi-year high.
Americans, meanwhile, are saving significantly less. In August, the US personal savings rate stood at just 4.8%. In fact, unlike Europe, savings rates in the US are actually below their pre-pandemic average.
What explains this divergence? It’s possible that cultural differences or varying levels of geopolitical uncertainty are responsible. A more compelling explanation, however, resides in the fact that Europeans generally own fewer stocks than Americans.
When combined with the relative outperformance of US markets in recent years, Americans may feel richer and thus less inclined to save as much money. In fact, empirical evidence indicates that strong stock market performance can lead to significant increases in consumer spending, which would also imply reduced savings.
Whatever the explanation, the effects of high European savings rates are largely negative for the continent. While high savings rates might benefit an individual, they can harm an economy by limiting overall consumer spending, an idea known as the paradox of thrift. Greater spending is doubtless one reason that the US economy has grown so much quicker than the European economy over the past year.
Moreover, because stock ownership is less broad-based in Europe, the continent is not seeing the investment benefits that might be associated with high savings rates. When savings are held in cash, rather than invested, businesses can struggle to access the financing they need to grow. Clearly, Europe’s saving habits aren’t as virtuous as they might initially seem.
Last Friday’s US jobs report took almost everyone by surprise. In September, the US economy added 254,000 jobs, compared with expectations of just 140,000. The unemployment rate, which was expected to stay steady at 4.2%, dropped to 4.1%. Average hourly earnings, meanwhile, climbed by the most in four months.
This report came as such a surprise thanks to a string of data in the past few months indicating that the labour market was beginning to cool. In a piece for Bloomberg, however, economist and investor Mohammad El-Erian argued that this run of mixed data will continue. In El-Erian’s view, the economy is becoming fundamentally less predictable, and we should grow accustomed to expecting the unexpected.
The primary driver of this change appears to be the fact that the Fed is becoming less influential in dictating the path of the economy through interest rate policy. Perhaps the greatest evidence for this assertion is the continued strength of the US economy over the past few years despite the Fed engineering one of the most rapid interest rate hiking cycles in history.
There are plenty of reasons that interest rate policy might be less influential today. The US economy is less capital intensive than it used to be, owing to the greater importance of technology and services. US consumers also have fewer adjustable-rate mortgages than they used to. But whatever the reasons, the result is that investors can no longer draw a simple connection between the Fed’s policy path and the future of the economy.
Further, El-Erian argues that a subtle shift in the Fed’s framework makes almost any predictive connection suspect. Rather than attempting to optimise the chances of a specific outcome, the Fed seems to be attempting to minimise the chances of a disastrous outcome, an approach that El-Erian calls an insurance mindset. This approach necessarily involves the Fed sacrificing some level of control over the mid and right tail in order to exercise greater control over the left tail.
Meaningful evidence for El-Erian’s view that the Fed is no longer in the driver’s seat of the economy will take time to accumulate. But for now, it provides a compelling reason why investors should prepare themselves for less predictable data moving forward.
Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.
