Market drift and rate rise threat – Monthly economic and market review
Jul 3, 2024The Australian All-Ords index rose 8.3% during the financial year ending last Sunday. But Australia’s economy has had a dismal time with real GDP per capita contracting in each of the five quarters to March 2024. With annual CPI inflation rebounding after earlier falls, the market now expects the RBA to further dampen consumer spending by increasing its cash rate from 4.35% to 4.6% in either August or September.
Happy New (Financial) Year!
My technical models show:
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- On short-to-medium-term trend analysis Australian All-Ords and American S&P 500 share indices are bullish. But the All-Ords is close to being bearish again.
- On medium-to-long-term trend analysis both the Australian and US markets remain 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.
Latest News
The Australian All-Ords index rose 8.3% during the financial year ending last Sunday. Its gross total return (including dividends but before taxation and franking credits) was up an estimated 12.1%, an excellent result!
But Australia’s economy has had a dismal time with real GDP per capita contracting in each of the five quarters to March 2024.
And since the end of December 2023, annual CPI inflation not only stopped falling but started rebounding. In May the CPI was 4.0% higher than in May 2023. See chart below.
The market now expects the RBA to further dampen consumer spending by increasing its cash rate from 4.35% to 4.6% in either August or September. Some think it could jump to 4.85% or 5.10% by year’s end unless inflation collapses quickly.
Higher rates would intensify mortgage stress for younger families yet boost savings income for debt-free retirees. Hopefully, Australia’s slowing economy will also slow inflation pre-empting the RBA from more rate hikes.
Not widely reported was that the May CPI increase on April 2024 was 0.24% (which translates to an annualised rate of 2.9%) and excluding volatile items was just 0.082% (which annualised is 1.0%). That would suggest inflation has already abated.
Market Drift
Since the end of February when the market surpassed its previous high in January 2022, the All-Ords has gyrated sideways. Investors are confused about the future, alternating between pessimism and optimism from week to week.
By contrast the US share market has continued in full bull mode since it surpassed its previous high point in January this year. No investor doubts in Wall Street. See next chart.
The S&P500’s outperformance is largely due to what are called the Magnificent-7 stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta). Of these Nvidia has been the the standout performer.
What the M-7 have in common is a passion for innovation. By comparison Australia’s share market is tech lite so is not benefiting from investor appetite for companies that are leading the technological revolution in AI (artificial intelligence), robotics, wearables (e.g., smartwatches, fitness trackers, and VR/AR headsets) and other ICT breakthroughs.
Bulls versus Bears
Bears say the All-Ords strong rally since the end of October 2023 could now end in a correction or crash since it was based on a false premise that the inflation fight was over so official interest rate cuts were imminent. Australian CPI data shows annual inflation is rebounding.
Bulls claim the stalled progress on inflation is temporary since elevated interest rates should weaken the labour market thereby reducing wage push pressures on services inflation, the main bugbear. Bears retort that unemployment has not yet risen sufficiently to stymie high wage demands.
Bulls say the CPI change between May 2023 and May 2024 is not as relevant as the change between April 2024 and May 2024. This month-on-month inflation was only 0.24% (which translates to an annualised rate of 2.9%) and excluding volatile items was just 0.082% (which annualised is 1.0%). The biggest volatile item was petrol prices which should drop if oil prices resume falling in step with China’s real money supply. See next chart.
Bulls also point to US and Australian GDP data for the March quarter which showed both economies were quickly slowing which should dampen inflation and thereby allow rate cuts.
Bears warn that the same data showed GDP inflation remained elevated suggesting both economies were slipping back into stagflation – high inflation with weaker economic activity. If so, it represents the worst of both worlds since it would prevent rate cuts and depress corporate earnings.
But bulls say that while CPI inflation in Australia remains sticky, inflation in America has resumed slowing. This gives cause for Fed rate cuts this year. Bears say the Fed has reduced its outlook for single 0.25% rate cuts this year from three to one suggesting it is becoming more hawkish.
Bulls argue that agonising about rate cuts is pedantic because the pandemic inflationary shock is over, and that slowing US and Australian economies will cool inflation further making interest rate cuts possible by late 2024 into 2025.
Bears say regardless of how inflation and interest rates pan out the US market is extremely overstretched on both technical and fundamental grounds. So, eventually Wall Street will crash and bring down every foreign market with it, just as happened in the dot.com bust of 2000-2002.
Bulls say that unlike the dot.com boom the bull market in M-7 stocks is based on strong earnings growth relative to the other S&P500 stocks, not irrational exuberance. See next chart. Furthermore, even if these stocks ultimately undergo a correction, it won’t greatly impact foreign share markets (including Australia) because they are tech-lite.
Fundamental Analysis
Sticky inflation, rising crude oil prices, a high cash rate, falling bond yields, and lower iron ore prices are weighing down the Australian share market. But offsetting this are the booming US share market, loose US credit conditions, and low world financial stress. As a result, the All-Ords index is not sure whether to advance or retreat.
On valuation metrics such as the Waren Buffet ratio (total market value divided by GDP) and the Robert Shiller ratio (total market value divided by cyclically adjusted earnings), the S&P500 is highly overvalued and the All-Ords is fairly valued. But in terms of projected profits growths Wall Street, thanks to the Magnificent-7 hi-tech stocks, looks more promising than Bligh Street (the home of the ASX).
Trend Analysis
Australia’s Market
On short-to-medium-term trend analysis, the All-Ords index went bearish and then back to bullish a fortnight ago. Its red 10-day trend line remains fractionally above its green 30-day one. Its price momentum as measured by the MACD has been slightly positive for the past four seven days. See Chart below.
So far in June the All-Ords has switched its status of bearish or bullish four times which is most unusual over a four-week period. What this shows is the All-Ords remains directionless, torn between forces pulling it up (such as Wall Street’s meteoric rise) and forces dragging it down (such as sticky Australian inflation).
On medium-to-long-term trend analysis, the All-Ords index remains strongly bullish. Its green 30-day trend line remains well above its blue 300-day one.
Unlike America, Australia’s stock market during 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 between October 2023 and March 2024 but since then has swung wildly sideways while the S&P500 continued to climb after a dip in April.
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 first wobbled before ascending higher.
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 since the Coppock is a monthly based index.
America’s Market
The Australian All-Ords index is highly correlated to the American S&P 500 index as shown by the following chart. About 70% of the All-Ords movements are in synch with the S&P500, meaning only 30% is caused by local or foreign events not impacting the USA. Hence the importance of tracking what is happening on Wall Street’s stock exchange.
America’s S&P500 share index is bullish on short-to-medium-term trend analysis since its red 10-day trend line remains above its green 30-day line. Its MACD momentum indicator was positive for the past eleven trading days until last Friday.
US investors have more faith in immaculate disinflation than their Australian counterparts, meaning they believe inflation is being beaten without requiring a credit squeeze and higher interest rates.
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. It remains so notwithstanding its temporary pullback in April 2024.
The dark green S&P 500 Coppock (COP) momentum indicator turned up at the end of March 2023 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.
Incidentally, the current US bull market has caught up to the average trend for such a market since 1957. See the next chart.