Pearls and Irritations

Two news items last week completely reversed the economic outlooks in Australia and America.

In Australia, the trimmed mean inflation rate for June was 3.8%, which was below the 4.0% expected.

This convinced economist that the RBA won’t increase its cash rate in August but instead will reduce it later this year if inflation keeps moderating.

In America, the labour market data for July showed a sudden deterioration in both jobs growth and unemployment raising fears of a recession.

This saw the S&P 500 index plunge on Friday which spilled over to global markets.

Market Trends
My technical models show:

• On short-to-medium-term trend analysis Australia’s All-Ords index remains bullish but America’s S&P 500 index has gone bearish.
• 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.

Market Pullback

Over the last week, the All-Ords share price index rose 0.2% after falling 0.7% the week before. During the week the index spiked at a new record high on Thursday but then plummeted 2.1% on Friday.

The Thursday spike was occasioned by better-than-expected Australian inflation news for the June quarter which ended speculation of another RBA cash rate rise in August. Indeed, economist now think that Australian interest rates have peaked and will fall by years end.

The Friday dive was triggered by weak US labour market data which raised fears that America could slip into recession unless its Federal Reserve cut interest rates quickly. This led to a global stock sell-off.

Notwithstanding Friday’s sharp pullback the All-Ords is still above its previous trendless trading range that existed from late February to early July. Also, it’s only down 2.1 % since its previous peak though it could fall further next week because of the dive in S&P 500 on Friday (Saturday Australian time). See chart below.

The next chart shows how the American S&P 500 index has fared of late. The index is down 5.7% since it peaked on 16 July 2024 mainly due to the slump in the Magnificent-7 hi-tech stocks.

Seasonal Volatility
The US share market normally becomes more volatile from August to November. See next chart. This year such volatility could be especially pronounced since US Presidential election years add to market uncertainty. And the coming US election campaign could be the most politically polarised and contentious for over a century. When Wall Street sneezes other markets catch a cold. So buckle up for more intense market moves than occurred in the last six months.

Economic News
Lynn Alden, an independent investment strategist, has aptly contrasted the differences of major economies in the current cycle as follows:

• China has had strong industrial production, but weak consumer spending.
• Europe has been relatively weak both in industrial production and consumer spending.
• America has been strong in consumer spending, but relatively weak in industrial production.                                                                       I should add:
• Australia like Europe has been relatively weak both in industrial production and consumer spending.

Last week was chock-a-block full of economic news. But there were two news items that completely changed the economic mood in Australia and America.

In Australia, the headline inflation rate for the 12-months to June was 3.8%, which matched the consensus forecast.

The trimmed mean inflation rate (which excludes the most extreme price changes in the CPI basket of goods and services) was also 3.8%, but this was below the 4.0% expected. This convinced economist that the RBA won’t increase its cash rate in August but instead will reduce it later this year if inflation keeps moderating.

In America, labour market data for July showed a sudden deterioration raising fears of a recession that could undermine corporate earnings many of which are already weakening. Initial jobless claims posted 249,000 versus consensus 235,000, the highest in nearly a year. Jobs growth was weaker-than-expected at only 114,000 extra jobs, indicating a sharp slowdown. The unemployment rate jumped to 4.3%, the highest since October 2021.

The key takes from the latest local and overseas economic data are:

• Australia’s inflation is still sticky but likely to resume falling.
• Australia’s building activity is weak, but its retails sales are edging up.
• America’s sudden labour market weakness warns of a potential recession.
• US and Euro inflation are still elevated but expected to fall further in future.
• Manufacturing activity everywhere is contracting, except in the UK.
• Europe’s economy is still expanding, notwisthanding Germany contracting.
• Britain has joined others in reducing its cash rate, but Japan is doing the opposite.

Investors want lower interest rates because that would boost equity and property prices.

Sweden Canada, Europe, Switzerland and UK have reduced their cash rates notwithstanding their inflation rates remaining above their central banks’ 2.0% target and staying sticky.

China has cut its policy rate to help stem its property bust while Japan has introduced a positive cash rate after eight years of negative cash rates to stem rising inflation.

In America month-on-month inflation ground to a standstill in June after falling for the last four months. The bond market now anticipates that the Fed will cut its funds (i.e. cash) rate in September.

Australia’s annual inflation rate remains above other OECD economies. However, the latest June quarter CPI data suggest the RBA won’t increase its cash rate in August and will reduce it later this year if inflation resumes falling.

US investors have decided that inflation is on the mend so is no longer a threat. Instead, recent poor company earnings and a sharp deterioration in America’s labour market have raised fears of a recession unless the Federal Reserve quickly cuts rates.

This change in mood has come suddenly since just over two weeks ago, Wall Street exuberance reached a zenith with artificial intelligence seen as the big breakthrough that would secure America’s prosperity for decades to come. Whether this turn in market sentiment is temporary or more lasting only time will tell.

All-Ords Drivers
Trends in the following factors largely drive the direction of the All-Ords index:

• Wall Street (the S&P 500),
• US financial conditions,
• World financial stress,
• Australian and US inflation,
• Treasury bond yield curves,
• Bond yield credit spreads,
• Copper price,
• Crude oil price, and
• Iron ore price.

Below are chart summaries of what they currently show.

1. Wall Street’s two main share price indices (S&P500 and the more hi-tech NASDAQ) are both now bearish. Growing disillusionment with the Magnificent-7 mega cap hi-tech stocks has triggered Wall Street’s sell off. This negative sentiment spilling over into other share markets including Australia.

2.

3. US financial conditions remain loose, which is a positive signal. See chart below.

4. Global financial stress is low, which is a good omen for stocks. See next chart.

5. Australian annual consumer price inflation after rebounding since last December, is trending down again according to the latest June quarter data released late last week. This has dashed fears that the RBA might have to increase its cash rate further to slay the inflation dragon.

6. Australian Government Bond’s 10 and 2-Year Yield Spread is positive suggesting an improved economic outlook over the longer term. But the yield curve shape between 1 and 10-years is still negative indicating economic pessimism over the shorter term.

Globally, except for Japan, all other large economies still have negative yield curves along the entire maturity spectrum which is ominous.

7. Moody’s bond yield credit spread is at an historic low meaning investors see minor risk between investing in a 10-year treasury bond and a low credit rated investment bond. That suggests few worries about a credit squeeze. Bond yield credit spreads are also low in Australia, see https://www.rba.gov.au/chart-pack/interest-rates.html However, credit spreads have been gradually creeping up since May, which needs close watching.

8. Copper price is falling reflecting China’s continuing deflation due to residential property and factory overcapacity which is imperilling global growth. Many think that “Dr. Copper” is the best barometer of global economic health because it is a versatile metal used everywhere from electrical wiring, transportation, construction, and telecommunications.

Note also that China is flooding the world market with cheap copper, a refection of its industrial overcapacity.

9. Oil price is falling which is welcome since it lowers consumer price inflation and improves the prospects of interest rate cuts.

10. Iron ore price is slipping again though is still at an elevated level. Iron ore is important to Australia because mining stocks comprise a large part of the All-Ords index and the Australian government’s income tax revenue.

Conclusion:
A falling US share market, falling iron ore prices, falling copper prices, and a negative yield curve are weighing down the Australian share market.

But better US and Australian inflation data, low bond yield credit spreads, loose US credit conditions, low world financial stress, falling oil prices and the ASX being tech-lite have mitigated the All-Ords retreat to date.

Should Wall Street keep falling on new concerns that America may be on the verge of recession then the All-Ords might continue falling too. But it’s too early to make that prognosis.

Trend Analysis

Australia’s Market

Short-to-medium-term trend analysis shows the All-Ords index has been bullish since 5 July with its red 10-day trend line remaining above its green 30-day one. But since spiking on 17 July, it has swung wildly sideways. The All-Ords price momentum as measured by the MACD has been positive for the past three trading days but is on the cusp of going negative again. See Chart below.

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 then the All Ords swung sideways until 11 July when it jumped its previous trading range.

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.

Last Friday America’s S&P500 share index went bearish on short-to-medium-term trend analysis since its red 10-day trend line fell below its green 30-day line. Its MACD momentum indicator has been negative for the past twelve trading days reflecting the pullback in the S&P500. This pullback now resembles the one of last April.

Until last Friday US investors believed inflation was over and the US Fed would soon cut its cash rate. Combined with a faith in artificial intelligence (AI) ushering in a new era of prosperity on the back of the Magnificent-7 mega hi-tech stocks, the future could not look brighter.

But recent poor earnings results by Tesla and Alphabet, mixed earnings for S&P500 companies for the second quarter and a strong jobs report on Friday (which raised fears of rate hikes) have turned investors from a “risk on” to a “risk off” mood.

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 pullbacks in April and July 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.

Asset Classes
Each month I produce “Rotation” charts showing how a selection of ASX-listed local and global sector funds have performed relative to each other over the previous nine months. This period is widely used for gauging an asset class’s medium-term price momentum. Here are the latest results for the nine months to now.

The black straight line in each chart represents Cash (AAA.ax) whose price is unmoved by market sentiment. Note that Gold (PMGOLD.ax) is a defensive asset that tends to rise when equities fall. For this reason, gold along with cash and investment grade bonds reduces downside risk in investment portfolios.

Local Assets

Within Australia, all sectors except Resources (QRE) remain positive with Property (SLF.ax) still in front followed Finance (OZF.ax) and Gold (GOLD.ax in third position. Resources are being worn down by China’s diminished economic prospects because of its collapsed property and infrastructure sectors and the West’s efforts to block its exports and hinder its technological progress. If America and its allies succeed in hobbling China’s economy, it will be bad news for Australia because it’s our biggest export market by far.

Economists are advising China’s government to lift its social and health care security benefits so that citizens can reduce their precautionary savings and increase consumer spending. China has one of the lowest consumption/GDP ratios in the world. But President Xi wants green technology and high-end manufacturing for exports to be China’s growth driver. He is working on the Global South replacing the Global North as China’s new market opportunity.

Global Assets
Globally, all sectors remain positive with the US Market (IVV.ax) still ahead of Gold (GOLD.ax) followed by Developed Markets outside the USA (IVE.ax) and Emerging Markets (IEM) tied in third place.

Economists keep predicting that US investors will rotate out of overvalued US stocks to better value non-US stocks, but it has still to happen. Analysts are also saying the disparity between growth and value stock and large and small cap stocks is at an extreme suggesting smart money will soon move to value and small cap stocks. But again, there is only a slight hint that this rotation has begun.

Global Assets
Globally, all sectors remain positive with the US Market (IVV.ax) still ahead of Gold (GOLD.ax) followed by Developed Markets outside the USA (IVE.ax) and Emerging Markets (IEM) tied in third place.

Economists keep predicting that US investors will rotate out of overvalued US stocks to better value non-US stocks, but it has still to happen. Analysts are also saying the disparity between growth and value stock and large and small cap stocks is at an extreme suggesting smart money will soon move to value and small cap stocks. But again, there is only a slight hint that this rotation has begun.