Pearls and Irritations

The American economy is strong, Australia’s economy has slowed to a standstill, and Xi Jinping is proving to be a dry economic rationalist rather than a warm indulgent socialist. Read on for this week’s global economic and financial review.

USA, Europe, and Japan

American economy is strong, and its inflation is accelerating. Yet its share market continues to boom on expectations of rate cuts following the Fed Chair’s recent assurance of that occurring soon. It seems the Fed is prepared to reduce interest rates provided inflation is tamed to 3%, not the official 2% target.

Money markets expect the Fed to cut its funds rate by 0.25% in June and by a total of 1.0% by December 2024. However, concern is growing that America’s rising month-on-month inflation rate could postpone such action. If that concern grows, its share market might stall or correct.

Europe’s economy is weak, and Japan’s is slowing. Inflation in most major economies is now hovering around 3% over the latest twelve months period. Japan is expected to lift its official cash rate and the cap on its negative bond yields by June this year since inflation is proving sticky. Share markets of all major developed economies, other than Britain, have boomed since troughing in October last year.

Major Developed Economies Share Markets

Australia

Australia’s economy has slowed to a standstill and its inflation is falling though is still too high for the Reserve Bank’s comfort. But its share market remains strong notwithstanding its recent pullback following further falls in iron ore and coal prices following China’s refusal to pump prime its struggling economy. The money market has priced in a 0.25% RBA rate cut by September and another one by December 2024.

The Australian share market has recovered since its slump in October last year. But being tech-lite, it has not done as well as the US market which is being propelled by its “magnificent-7” hi-tech stocks.

China and India

On published data, both China and India’s economies remain strong, though many economists disbelieve that China is growing at 5% and think it is half that. Indeed, its key economic indicators show it is recessed and suffering deflation. The bright spots are a recent pickup in retail sales and stronger factory output.

China’s National People’s Congress last week rubber stamped President Xi’s refusal to stimulate the economy since it would add to government debt. China could be entering a balance sheet recession as Japan did after 1990. Its decision to deleverage (reduce its national debt/GDP ratio) has slowed its growth, depressed its prices, and caused high youth unemployment. At the same time, Xi objects to China becoming a welfare state since he thinks families should look after themselves.

Also, he is refusing to rescue insolvent property developers and local governments believing economic restructuring should happen through market forces. Ironically, Xi is proving to be a dry economic rationalist rather than a warm indulgent socialist. His only, but important concession to improving social equity was significantly increasing the minimum subsistence allowance for low-income people which alleviated extreme poverty over the last decade.

But on micro-economics, Xi Jinping is as interventionist as Joe Biden, favouring state subsidies for green energy and hi-tech industries as the way to turbo-charge the economy. That includes electric vehicles, lithium batteries, solar panels, and microchips.

India’s share index is now double what it was before the 2020 pandemic while China’s share index is no higher than then. India is following China’s previous model for achieving high growth – debt fuelled infrastructure and property development, promoting exports, and deregulating private enterprise – but also prioritising services, especially IT and software, healthcare and pharmaceuticals, and high-turnover non-durable consumables.

After recovering from the pandemic crash, Chinese stocks have been falling since the end of 2022. But since early February they have jumped following the government urging companies to buy back their own shares.

Bulls versus Bears

Bears are now on the front foot following the market’s sharp pullback from its all-time peak a week ago. They warn the All-Ords spike mirrored Wall Street’s “irrational exuberance” over AI stocks, so was not a genuine breakout from its sideways drift of the last three years.

Bears say China’s collapsing economy is a game changer and will drag our resources sector, government finances and general prosperity down with it. Also, aggressive home loan rate rises between May 2022 and November 2023 (see chart below) are shredding many Australian household budgets forcing families to cease their discretionary spending.

Bulls say that since September 2022 the All -Ords index has been climbing a “wall of worry” which is normal for a new bull market. In their view the market pullback in the last fortnight is an overreaction to concerns about China and interest rates taking longer to fall than expected.

Bulls believe the global economy is over its worst because inflation is falling, and global financial stress has significantly eased since the middle of last year. See chart below. Moreover, China’s communist government knows that to survive it must keep lifting the living standards of its citizens so it will do whatever it takes to restore its economy to health.

Note: By financial stress, the index means disruptions in the normal functioning of the four major financial markets: the banking sector, the foreign exchange market, the equity market, and the debt market.
Source: https://www.financialresearch.gov/financial-stress-index/ 

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 an 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.