Stretching credulity
Fed Chairman, Jay Powell says the US economy is strong.
But they have cut interest rates three times this year.
And it’s all hands to the pump below decks. The Fed expanded their balance sheet by $288 billion since September and broad money (MZM plus time deposits) growth has almost doubled to $1.4 trillion this year.
Donald Trump says that a Phase 1 trade deal has been settled with China.
But the two parties can’t seem to agree on whether China’s agricultural purchases are part of the deal (China is reluctant to commit to a $ amount).
Nor can they recall whether rolling back tariffs was part of the deal. China would like to think so but Trump is now threatening to increase tariffs if a deal isn’t signed.
Fundamentals show that activity is contracting. Industrial production is falling.
Freight shipments are contracting.
And retail sales growth is declining.
Yet Dow Jones Industrials just broke 28,000 for the first time, while Trend Index troughs above zero show long-term buying pressure.
“Explosive” is the right word.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Gold, Silver and Treasury yields
10-Year Treasury yields retraced from resistance at 2.0% this week but rising Trend Index troughs indicate upward pressure on yields. Breakout above 2.0% would strengthen the signal. Higher long-term rates would increase the opportunity cost of holding Gold, reducing demand.
China’s Yuan penetrated its descending trendline against the Dollar. Similarities between the two patterns (above and below) suggest that China is reducing purchases of Treasuries, increasing upward pressure on yields.
Rising yields would normally strengthen demand for the Dollar. Instead, declining Trend Index peaks warn of long-term selling pressure.
Gold found short-term support at $1450/ounce but further rises in Treasury yields would increase the selling pressure highlighted by declining peaks on the Trend Index.
Silver broke support at $17.00/ounce, with an even steeper fall on the Trend Index warning of a further decline on Silver and Gold.
Australia’s All Ordinaries Gold Index continues its downward trend channel, headed for secondary support at 6000. Declining Trend Index peaks again warn of strong selling pressure. Respect of 6000 would signal that the primary up-trend is intact, while breach and a test of primary support at 5400 would again warn of trend weakness.
Patience
Gold is in a long-term up-trend. A correction may offer an attractive entry point but we first need to confirm that the up-trend is intact before increasing exposure to gold stocks.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
ASX 200 diverges from fundamentals
Seasonally adjusted labour force estimates show a decline in October 2019:
- Employment decreased by 19,000 to 12,919,200 people
(full-time -10,300 and part-time -8,700). - Unemployment rate increased by 0.1 pts to 5.3%.
- Monthly hours worked in all jobs decreased by 2.8 million hours to 1,783.9 million hours.
The leading indicator of employment has been predicting a down-turn in employment for some time, recording its sixteenth consecutive monthly fall in November.
Job advertisements have also declined since late 2018.
Falling employment has a knock-on effect in other areas of the economy:
According to Tony Weber, chief executive of the FCAI, new vehicles have now seen the nineteenth consecutive month of decreasing sales in the Australian market, with October 2019 sales down 9.1% compared to October 2018.
“Year to date sales of new motor vehicles in 2019 are almost 78,000 units (eight per cent) lower than the same period in 2018…”
Retail sales are also soft:
In volume terms, the seasonally adjusted estimate for the September quarter 2019 fell 0.1%. This follows a 0.1% rise in the June quarter 2019, and a 0.1% fall in the March quarter 2019.
But the ASX 200, seemingly unperturbed, is testing resistance at 6800. Breakout would signal a primary advance with a target of 7200. Breach of support at 6400 seems unlikely but would warn of a decline with a target of 5400.
There are, however, signs of weakness in the largest two sectors.
ASX 300 Banks index penetrated its rising trendline, warning of a correction. Declining peaks on the Trend Index indicate secondary selling pressure. Follow-through of the index below 7600 would strengthen the bear signal.
A hanging man candlestick warns the ASX 300 Metals & Mining index is likely to again test support at 4100 ( the neckline of a large head-and-shoulders reversal pattern ). A Trend Index peak near zero would indicate continued selling pressure.
Iron ore continues its primary decline, since breaking support at 90. Our long-term target is 65.
We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook. But ASX 200 breakout above 6800 would force us to re-examine our outlook.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Australia: Major banks
Summary
Our review of APRA’s June 2019 quarterly report on the four major banks — Commonwealth, Westpac, ANZ and NAB — concludes that they are collectively priced at a 16.5% premium over fair value.
Technically, the ASX 300 Banks Index ($XBAK) is experiencing secondary selling pressure and a correction is likely.
A correction would reduce the premium over fair value and may present buy opportunities.
Valuation
We project:
- long-term asset growth at 3.0% p.a. (down from 4.0%);
- net interest margins at 1.65% of average total assets (down from 1.70%);
- non-interest operating income of 0.5%;
- operating expenses at 1.05% (previously 1.10%);
- provisions for bad/doubtful debts averaging 0.2%;
- additional equity capital required of $12 billion; and
- a 30% tax rate.
That delivers a forward PE of 16.9 based on a market cap of $399 billion.
We estimate that the major banks are priced at a 16.5% premium over fair value, based on a 12-year payback period*.
*Note to readers: we have simplified our model by removing the margin of safety and use a lower payback period instead.
Technical Analysis
The ASX 300 Banks index retreated below its rising trendline, warning of a correction. Follow-through below support at 7600 would strengthen the signal, with a target of primary support at 6750.
Book Growth
Total assets are the primary engine of bank revenue. Heady growth of the last two decades ended in 2015, when the ratio of total assets to nominal GDP (right-hand scale) started to decline. Nominal GDP also slowed (5.4% p.a. in June 2019) and is likely to restrict future book growth.
Household debt near saturation level, at close to 200% of disposable income, is another headwind to future book growth.
Total asset growth of the major four banks slowed to 1.4% for the twelve months ended June 2019 and we have reduced our long-term projection to 3.0% per year.
Margins
RBA rate cuts are squeezing net interest margins, currently 1.73%, and we expect a long-term average of 1.65% of total assets.
Expenses declined to 1.09% of total assets but non-interest income, at 0.56%, is falling even faster.
Non-Interest Income
Fees and commissions — the major component of non-interest income — have suffered the largest falls. Transaction-based fees are the worst performer, while declining credit growth has reduced lending-based fees. The sharp drop in other fees, to 0.19%, is likely to be permanent as banks shed their wealth management operations.
We project non-interest income to average 0.50% of total assets in the long-term.
Expenses
Operating expenses declined to 1.09% of total assets, as the majors attempt to cut costs in line with income, but personnel costs have proven sticky and are falling at a slower rate.
Non-Performing & Past Due Assets
Charges for bad and doubtful debts remain low at 0.09% of total assets but we expect a long-term average of 0.20%.
Impaired loans are falling as a percentage of total loans and advances but past due loans have climbed to 0.6%, reflecting mortgage stress.
Provisions for impaired loans, however, are reasonable at 95.8% of impaired facilities including security held.
Capital
Common equity Tier 1 capital (CET1) remains low, with a CET1 capital ratio of 10.8% in June 2019, based on risk-weighted assets. CET1 as a percentage of total assets is a low 4.96%.
The Reserve Bank of New Zealand has called for “more skin in the game“, asking the big four Australian banks to increase their capital holdings in New Zealand subsidiaries by $12 billion:
The RBNZ proposal calls for systemically important banks to hold a minimum of 16% Tier 1 capital against risk-weighted assets, of which 6% would be a regulatory minimum and 10% would act as a counter-cyclical buffer to absorb losses without triggering “resolution or failure options”.
A similar move by APRA is unlikely but RBNZ presents a problem for the big four banks as they will have to raise additional equity to capitalize their NZ subsidiaries. One alternative is to raise equity through a separate listing of their NZ subsidiaries but this is still likely to dilute returns on equity.
Return on Equity
Declining return on assets and increased capital requirements are both exerting downward pressure on return on equity (ROE), from a peak of 20.5% in 2007 to 9.7% in March 2019.
Management & Culture
Australian regulator APRA is suffering from regulatory capture. A 146-page capability review, stemming from David Murray’s Financial System Inquiry found APRA “slow, opaque, inefficient, and in urgent need of a culture and leadership overhaul.”
Disclosure
Staff of The Patient Investor may directly or indirectly own shares in the above companies.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Business confidence sags
Australian business confidence is sagging, according to the latest Roy Morgan poll, signaling the end of the post-election bounce*.
Source: Roy Morgan Business Single Source, Dec 2010-Oct 2019. Average monthly sample over the last 12 months=912.
- A decreasing number of businesses (40.7%, down 5.8ppts) expect the Australian economy to have ‘good times’ economically over the next year while 52.4% (up 4.2ppts) expect ‘bad times’;
- In addition, just 44.1% (down 7ppts) of businesses expect ‘good times’ for the Australian economy over the next five years and 45.9% (up 2.9ppts) now expect ‘bad times’.
RBA interest rate cuts don’t seem to be working.
A similar picture is emerging in the US, where CEO confidence is near recession levels.
CEO confidence affects hiring and investment decisions and is an important leading indicator for GDP and earnings growth.
*Hat tip to Macrobusiness.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Gold plunges
Gold broke support at $1490/ounce, the base of a bearish descending triangle. A sharp drop on the Trend Index warns of strong selling pressure. Respect of secondary support at $1350 would signal that the primary up-trend is intact, while a test of primary support at $1270 would warn of trend weakness.
Silver similarly broke support at $17.50/ounce, with an even steeper fall on the Trend Index warning of a strong decline, confirming the Gold signal.
The cause of the sharp fall is clear: long-term Treasury yields are rising, increasing the opportunity cost of holding Gold. 10-Year Treasury yield breakout above 2.0% would warn of an up-trend, with an initial target of 2.50%.
The All Ordinaries Gold Index continues its downward trend channel, towards secondary support at 6000. Declining Trend Index peaks again warn of selling pressure. Respect of 6000 would signal that the primary up-trend is intact, while a test of primary support at 5400 would again warn of trend weakness.
Patience is required
Gold is in a long-term up-trend and a correction may offer an attractive entry point. But we first need to confirm that the up-trend is intact before increasing exposure to gold stocks.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
ASX banks profit squeeze but miners bullish
Iron ore continues its primary decline, having broken support at 90. Expect a test of the long-term target at 65.
ASX 300 Metals & Mining index rallied during the week. I was expecting another test of support at 4100 ( the neckline of a large head-and-shoulders reversal pattern ) but a higher Money Flow trough near zero indicates buying pressure. A large divergence between iron ore and the Metals & Mining index warns that something is afoot.
The CEOs of ANZ, Westpac and NAB this week all mentioned pressure on net interest margins in their earnings announcements.
But as this chart of fee and other income to March 2019 shows, it is not just interest margins that are under pressure. Transaction fees are steadily declining, while low book growth in recent years has resulted in declining lending fees. The recent sharp fall in other fee-based activity is also unlikely to recover as banks shed their troublesome wealth management business units.
Source APRA: Major Banks
ASX 300 Banks index retreated below its rising trendline, warning of a correction. Declining peaks on the Trend Index indicate secondary selling pressure. Follow-through below 7600 would strengthen the signal.
REITs have been experiencing selling pressure in the last few months despite the scramble for yield, with descending peaks on Twiggs Money Flow and a bearish descending triangle. Breach of support at 1600 would offer a short-term target of 1500.
ASX 200
Financials are mildly bearish but miners are surprisingly bullish. An ascending triangle on the ASX 200 signals buying pressure, while the declining peaks on Money Flow are modest in relation to the overall up-trend. Breakout above 6800 would signal another advance with a target of 7200. Breach of support at 6400 is now less likely but would warn of a decline with a target of 5400. As always, the two biggest sectors, Financials and Mining, are likely to point the way.
We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook. But ASX 200 breakout above 6800 would force us to review our outlook.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
Medibank Private Ltd (MPL) plunges on cost spike
Medibank Private (MPL) broke support at 3.20 and its rising trendline, warning of a decline to test primary support at 2.30. Closing of the gap at 2.90 would strengthen the signal.
We eliminated our exposure in July 2019 after the crisis facing Australian private health insurers was first highlighted. Rising costs force up premiums which in turn makes it difficult to attract new subscribers. A shrinking base of younger, healthier members — who subsidise older members with higher costs — threatens a self-reinforcing spiral.
Patrick Hatch at The Age reports on the latest cost spike:
Medibank Private chief executive Craig Drummond says an “alarming” and “curious” increase in surgeries involving prosthetic devices is driving up costs and threatening the stability of the private health sector….
Mr Drummond said claims were driven higher by the volume of prostheses — such as hip and knee replacements and other medical devices — which grew by 8.5 per cent last year, compared to 2 per cent and 4 per cent growth in the previous two years, respectively.
“We’ve got surgical volumes that are flat-ish, and we’ve got prostheses volumes that are close to double digits,” he told investors.
“We’re very curious about what’s going on. Something doesn’t feel right. It’s quite inverse to the situation that we’ve had over the last two or three years.”
A deal between government and medical device makers to put a cap on how much insurers had to pay for prostheses was supposed to deliver $200 million in savings last year. But Medibank said it only saved $13 million because of the rise in the number of devices being implanted.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
ASX: Iron ore breaks support
Iron ore broke support at 90, falling sharply to $83.55/ton. Expect a decline to test the long-term target at 65.
ASX 300 Metals & Mining index rallied slightly but another test of support at 4100 is likely — the neckline of a large head-and-shoulders reversal pattern. Declining peaks on the Trend Index warn of selling pressure. Completion of the head-and-shoulders reversal would offer a target of 3400.
Residential mortgage activity is recovering in response to recent rate cuts but banks are under pressure, with lower interest margins, lower fee income and high remediation costs from malpractices exposed by the Royal Commission.
ANZ reported a flat full-year profit at $6.4 billion but revealed margin and retail fee pressure:
“The halving of the Reserve Bank’s cash rate during the year was the major factor in a 12 basis point compression of ANZ’s net interest margin to about 1.72 per cent. The net interest margin is the difference between the bank’s funding costs and what it charges for loans, and it’s as low as it has ever been – in the mid-1990s the margin was about 4 per cent – with no reason to believe the pressure on margins will abate.” [Stephen Bartholomeusz]
ASX 200 Financials index met resistance at 6500. Declining peaks on the Trend Index now indicate selling pressure. Expect a test of primary support at 6000; breach would offer a target of 5300.
REITs recovered slightly from their recent sell-off but the descending triangle is bearish. A lower Trend Index peak would strengthen the bear signal. Breach of support at 1600 would offer a short-term target of 1500.
ASX 200
The ASX 200 continues to give mixed signals. An ascending triangle on the index chart is bullish, but declining peaks on the Trend Index warn of selling pressure. Breakout above 6800 would signal another advance, while breach of support at 6400 would warn of a decline with a target of 5400. The two biggest sectors, Financials and Mining, are likely to lead the way.
We maintain low exposure to Australian equities, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.