Pearls and Irritations

Last Friday the All-Ords share index finally escaped its straitjacket of see-sawing sideways within a range of roundly 6,600 to 7,900 since April 2021. The All-Ords reached 8007.1 points, beating its previous high on the 4 January 2022 (7926.8). See chart below. Technical analysts view this breakout to be a particularly good omen.

The breakout can be attributed to financial stocks leaping ahead in the last two months notwithstanding materials (metals & mining) having fallen back.

The Australian stock exchange is dominated by banks and miners so their performance largely dictates how the All-Ords performs. Because financials constitute almost 30% of the share market’s total worth their advance has outweighed the fall in materials which comprise around 22% of the market. See next chart.

Trend analysis

Australia’s market

On short-to-medium-term trend analysis, the All-Ords index is bullish since its red 10-day trend line is above its green 30-day one.
Its price momentum as measured by the MACD went positive last Friday after having been negative for almost three weeks.

On medium-to-long-term trend analysis, the All-Ords index is bullish. Its green 30-day trend line is well above its blue 300-day one.

Unlike America, Australia’s stock market for most of last year swung sideways because it has few tech stocks promising new riches through AI (artificial intelligence). However, the All-Ords like the S&P 500 enjoyed a strong rally in November and December not just in hi-tech stocks but across the board.

The All-Ords dark green Coppock (COP) momentum indicator bottomed at the end of December 2022 and thereafter trended up into positive territory where it has wobbled, but still stayed modestly positive.

In the past whenever the Coppock turned up in negative territory it signalled the end of an Australian bear market. Only end of month readings are meaningful for the Coppock since it is a monthly signal.

America’s market

Technology stocks are making new highs, driven by advances in AI and fuelled by rising liquidity in financial markets. As a result, America’s S&P 500 share index continues to be bullish on short-to-medium-term trend analysis since its red 10-day trend line is comfortably above its green 30-day line. Its MACD momentum indicator went positive in the last week after being negative the previous week.

The S&P 500 index’s medium-to-long-term trend went bullish on 14 April 2023 after the S&P 500 share index’s green 30-day trendline rose above its blue 300-day trendline. It became extremely bullish after its 10.3% correction in August to October 2023.

The dark green S&P 500 Coppock (COP) momentum indicator turned up at the end of March and thereafter has continued rising and is strongly positive which confirms that the previous US bear market is well and truly over. Only end of month readings count for the Coppock since it is a monthly signal.

Economic analysis

Reinflation concern

At the start of the year the outlook was for “immaculate disinflation” – inflation and interest rates to fall without requiring a recession and high unemployment. But this Goldilocks scenario – “not too hot, not too cold, but just right” – was challenged by rising month-on-month inflation in the USA and sticky inflation elsewhere. See next chart for the USA.

The January core personal consumption expenditure (PCE) price index — the US Federal Reserve Bank’s preferred measure of underlying inflation — jumped by 0.42% or 5.0% annualised. See below.

And the Services PCE price index — which worries the Fed the most — was even higher in January, being 0.60% or 7.2% annualised.

Loose fiscal policy

Lyn Alden, in her latest Investment Strategy Newsletter, says reflation is occurring because fiscal policy is now more stimulatory than monetary policy is contractionary. In her own words:

“After major inflation began to take hold in the United States and other developed countries in 2021, the Fed and other central banks began to push back with tighter monetary policy in early 2022, to try to contain it…. Partially by late 2022 and especially by early 2023, ongoing loose fiscal policy in the United States began to balance out that tight monetary policy, resulting in a tug-of-war of sorts.

“(But since the start of 2024), the fiscal side is showing evidence of wining. The unstoppable force is moving the immovable object, although we need to see if the data continue to confirm it in the months ahead.

“History does show that between the two, the fiscal side almost always wins. It can be a bumpy ride at times, but as long as a country controls its own currency, when problems really hit the fan, they almost always print.”

Though Alden does not say so, being an election year the US government’s deficit funded spending seems more likely to speed up than slow down. Also, the Inflation Reduction Act (aimed at tackling climate change, improving energy infrastructure, subsidising American industry, and promoting equity) will increase budget deficits over the next few years even though it should reduce them in total by $237 billion over the next decade according to the Congressional Budget Office.

Rate implications

A reigniting of US price inflation would cause the US Fed to postpone any official rate cuts it plans for the second half of the year. Indeed, it could cause it to go into reverse gear and raise its fund (i.e., cash) rate further. See chart below. That might make it harder for other central banks to cut their rates since that could devalue their currencies which would be inflationary.

According to JP Morgan Research a second inflation wave in the US could be problematic for stocks based on what happened to the S&P 500 share price index whenever inflation resurged in the 1970s. See chart below.

Disinflation expectation

However, most analysts think the recent upturn in month-on-month US inflation will prove to be a temporary aberration to an otherwise downwards trend as pandemic disruptions to material, labour and inventory supplies disappear. In their view increased US fiscal stimulus in the last year has stopped the US economy sinking into recession, so has not stoked inflation.

They cite that US inflation on an annual basis is almost back to where it got in June 2023. See next chart. Yet this is still too high for the Federal Reserve which remains committed to getting inflation below 2.0% before it considers cutting its cash rate.

New breakout or last hurrah?

Bears are on the back foot because the market has finally escaped its horizontal gyrations since April 2021. Yet they warn the new All-Ords spike is just mimicking Wall Street’s “irrational exuberance” over AI stocks which will end in a crash. Also, aggressive monetary tightening between May 2022 and November 2023 will eventually wreak havoc on the economy and earnings because such tightening always takes around 18 months to be felt.

Bulls say that since September 2022 the index has been climbing a “wall of worry” which is normal for a new bull market. Moreover, it has finally broken out of its horizontal trading channel over the past three years. Bulls claim the market’s rally will continue given the resilience of economies here and abroad which is being propelled by loose financial conditions and the prospect of central bank interest rates being cut this year.

Who’s right?

Bulls and bears cannot both be right. 2024 will decide the fate of both economies and markets, a hard, soft or no landing. If positive investor sentiment triumphs, it will be the second year that economic theory got it wrong. Normally, tight monetary policy, high oil prices and falling real wages trigger a recession after a lag. So, if that fails to eventually happen, economics will be turned on its head.

What my models say

I do not forecast markets because those who do so generally get it wrong. Nor do I give investment advice. Instead, I gauge the market’s present trend and momentum to let Mr Market speak for himself. Then I try to rationalise Mr Market’s behaviour on monetary, fiscal, economic, or political grounds or technical ones such as overreach correction.

My technical models show:

• On short-to-medium-term trend analysis both the Australian All-Ords index and the American S&P 500 are bullish.
• On medium-to-long-term trend analysis the Australian and US markets are also bullish.
• The Coppock momentum indicators of both markets are positive. They turned up in negative territory early last year signalling the previous bear market was over.