Author: Colin Twiggs

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.
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Tectonic shift threatening the global reserve currency system

As Mark Carney observed at Jackson Hole: the global reserve currency system is broken — it has been since Nixon defaulted on gold backing for the Dollar in 1973 — and there is no fix. We have to find a replacement along the lines of Carney’s suggestion. On Macrovoices, two experts on the EuroDollar system, Jeffrey Snider and Luke Gromen discuss the massive tectonic shift facing the global financial system.

https://www.macrovoices.com/683-macrovoices-184-luke-gromen-jeff-snider

This is a complex topic but it is important that we grasp the implications before a tsunami appears on the horizon.

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The defining issue of our time

“This is the defining issue of our time. From the economic war, to the currency war, capital markets war, it will come with further and further exposure. The future of not just our country, but the peace and prosperity of the entire world is going to hinge on this.” – Steve Bannon

Click here to view the video: Twitter/GlobalHimalaya Project

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S&P 500: Upside limited, while downside risks grow

Corporate profits (before tax) ticked up slightly in the second quarter of 2019 but remain below 2006 levels in real terms. The chart below shows corporate profits adjusted for inflation using the GDP implicit price deflator.

Real GDP and Hours Worked

Growth in production of durable consumer goods remains week, reflecting poor consumer confidence.

Durable Goods Production

The chart below shows growth in bank credit and the broad money supply (MZM plus time deposits). Credit growth (blue) remains steady at around 5%, slightly ahead of nominal GDP growth (4.04% for 12 months ending June); a healthy sign. Broad money (green) surged upwards in the first three quarters of this year. Not an encouraging sign when there were similar surges in broad money before the last two recessions.

Broad Money & Credit Growth

The S&P 500 is testing resistance at 3000. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure. Expect a test of support at 2800. Breach would flag a reversal, with a target of 2400.

S&P 500

The cyclical Retailing Index displays a similar pattern, with resistance between 2450 and 2500.

Retail

Our view is that upside is limited, while downside risks are growing.

On the global front, the outlook is still dominated by the prospect of a prolonged US-China trade war. More great insights from Trivium China:

Tariff delays may be aimed at creating warm, fuzzy feelings before the next round of talks in early October, but……These small gestures do nothing to resolve the underlying trade conflict. We’re still pessimistic on prospects for a deal.

Zhou Xiaoming – China’s former top diplomat in Geneva – expressed the same view in a recent interview (Guancha):
“The two sides disagree too much on the objectives of the negotiations……It is almost impossible to reach an agreement in the short term.”

Zhou urged Chinese officials to be clear on the US’s objective:
“Economic and technological decoupling is the objective of the entire US government.”

Zhou said that officials must prepare for that potentiality, even if it is not their desired outcome.

So should we.

Dow Jones – UBS Commodity Index found support at 76 before rallying to 79. Rising troughs on the Trend Index reflect increased support. Consolidation between 76 and 81 is likely but we maintain our bearish long-term outlook for commodities.

DJ-UBS Commodities Index

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Trend Index peaks below zero indicate selling pressure. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our investment in quality growth stocks but have reduced equity exposure to 40% of (International Growth) portfolio value.

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ASX: Iron Ore expected to decline to $55 per ton in next five years

Iron ore found short-term support at $90 per ton but this is unlikely to hold and our medium-term target is $80 per ton.

Iron Ore

Bloomberg published an interesting outlook on iron ore this week from Ed Morse, Global Head of Commodities Research at Citigroup:

“Steel demand is no longer going to be what it was,” Morse said in an interview. “No combination of India, Brazil and any other emerging-market country, no matter how big, is going to replace what China did alone,” he said, referring to spike in demand from the nation’s “fixed-asset investment extravaganza,” between the 1990s to 2010.

….Benchmark prices will end this year at the mid-$90s a ton, before falling to $75 at the end of 2020, he said. Five years out, they are seen at $55 a ton — a level that’s still well above current costs of production at the largest miners.

The ASX 300 Metals & Mining index found support at 4100 but the outlook is increasingly bearish. Breach of 4100 would complete a head and shoulders reversal with a target of 3400.

ASX 300 Metals & Mining

Given the importance of mining exports to the Australian economy, a fall in iron ore prices would be likely to increase downward pressure on the Aussie Dollar.

The Financial sector, on the other hand, is looking bullish at present, with Trend Index troughs above zero indicating buying pressure, in response to improved auction clearance rates. But housing woes are far from over and we expect them to remain a drag on growth for the next three to five years.

ASX 200 Financials

The ASX 200 continues to edge upwards, heading for another test of resistance at its 2007 high of 6800. Hanging man candles over the last three weeks warn of profit-taking, which is slowing the rally’s progress. Expect stubborn resistance at 6800. Reversal below 6400 would warn of a decline to test primary support at 5400.

ASX 200

We increased exposure to Australian equities, to 25% of portfolio value, this week but with an increased focus on defensive stocks, because of our bearish outlook.

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Telstra Corp Ltd (TLS)

Stock: Telstra Corp Ltd
Exchange: ASX Symbol: TLS
Date: September 12, 2019 Latest price: $3.59 AUD
Market Cap: $42.9 bn Fair Value Estimate: $3.83
Forward P/E: 16.6 Fair Value Payback: 13 Years
Financial Y/E: 30 June Rating: Hold
Sector: Communications Services Industry: Telecom Services
Investment Theme: Dividends & Growth Forward Dividend Yield 2.81% (fully franked)

Summary

Telstra is a defensive stock with dominant market share in mobile, broadband and the rapidly shrinking fixed line market.

We assign a fair value of $3.83 based on an EBITDA of $7.7 billion (net of $3 billion hole from NBN roll-out less $1.3 billion in expected cost savings), 4% long-term growth, $10.7 billion compensation from the NBN rollout (net of expected future redundancy costs), a 10% margin of safety and a 13 year payback period.

Telstra would not be suitable for international investors who cannot take advantage of franking credits on dividends.

Our current rating is HOLD because of the correction on the chart below. We plan to upgrade this to BUY if Trend Index (13-week) forms a trough above zero.

Recommended portfolio weighting is 5% of portfolio value.

Technical Analysis

Telstra is currently undergoing a correction after an impressive rally since the start of 2019. We expect the correction to find support at $3.20. A Trend Index trough above zero would indicate buying pressure.

Twiggs Momentum and Trend Index (13-Week)

Company Profile

Telstra is the largest player in the Australian telecommunications industry and owns and operates an extensive telecommunications network. Telstra markets voice, mobile, broadband and pay television (35% of Foxtel) and enjoys strong brand recognition. They boast the widest mobile coverage and jealously guard competitor access to their network.

Competitors & Markets

Optus (a subsidiary of SingTel) competes mainly in mobile, broadband and voice. It owns and operates its own network but also uses the wholesale services of the NBN and Telstra. Optus was making inroads in the broadband and mobile markets, bundling services with free sports coverage of the 2018 Soccer World Cup, but this led to an embarrassing failure when their network proved incapable of handling the traffic volume.

TPG Telecom Ltd (TPM) is an Australian telecommunications company and one of the fastest growing domestic Internet service providers in Australia. Under the TPG, AAPT and iiNet brands, the group enjoys a 26% share of the Australian broadband subscriber market (or 1.9 million subscribers). Margins have suffered as migration to the NBN grows.

TPG proposed a merger with third mobile network provider Vodafone but this has so far been blocked by the Australian Competition and Consumer Commission (ACCC) on the grounds that the merger would lessen competition between mobile players. Vodafone has appealed the decision.

The ACCC found that TPG would have the capacity to roll out a new 4G mobile network in the coming years and therefore allowing the two parties to merge would remove this additional competitor from the market. TPG’s counsel Ruth Higgins told the court that TPG's ability to build a 4G network was already outdated with new 5G technology. "5G isn't just a possibility. It's a product." (The Age)

TPG is the second biggest player in fixed broadband and Vodafone ranks third in mobile. A deal would leverage Vodafone's existing underutilized mobile network and save TPG on infrastructure spending. A combined entity would still rank third in mobile but would be more able to compete with Telstra and Optus in the 5G market, spreading the large capital costs over a broader subscriber base.

5G Wireless Network

Extensive capital outlays required to implement 5G are only within the means of the largest players. Telstra's choice of Ericsson as its major 5G supplier has given them an advantage over Optus who had tied up with Huawei before the Australian government banned them from supplying 5G equipment:

Australia's secretary for foreign affairs and trade said her government's guidance to keep equipment from Chinese makers Huawei Technologies and ZTE out of 5G wireless networks was made after national security risks were assessed from "all possible angles." (Nikkei Asian Review)

Why Invest in Telecommunications?

The Australian telecommunications industry has gone through a torrid time in the past two years, with disruption from the National Broadband Network (NBN) eroding the competitive advantage of larger players and consequently margins. The ASX 300 Telecommunications Index fell more than 56% between 2015 and 2018.

ASX 300 Telecommunications Index

The Australian telecom industry occupies a unique defensive position. The industry is dominated by a few players, with low threat of competition from offshore because of the massive infrastructure investment required and high existing levels of penetration in a mature market.

Total number of broadband subscribers increased to 14.21 million in December 2017 from 13.64 m a year earlier (ABS), a growth rate of 4.2%. But data usage is growing exponentially, with downloads up by 38.6% to 3.6 million Terabytes (TB).

Australian Broadband Usage

Source: ABS

Mobile usage shows a similar pattern with subscribers up by 4.9% to 26.7 million by December 2017, while data downloads increased by 39.1%.

Structural trends show promise, with online services and the Internet of things — rising connectivity across devices from motor vehicles to television sets and refrigerators — expected to grow exponentially.

Wireless and mobile data usage are small (9%) compared to fixed line broadband but that is expected to change. Telstra has commenced roll-out of the 5G network which offers data rates of several tens of Mb/s and supports hundreds of thousands of simultaneous connections required for massive sensor deployments under the Internet of things.

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.

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China: Exports fall despite weaker Yuan

Reuters says that export orders are falling and the contraction is expected to worsen in coming months:

Beijing is widely expected to announce more support measures in coming weeks to avert the risk of a sharper economic slowdown as the United States ratchets up trade pressure……

On Friday, the central bank cut banks’ reserve requirements (RRR) for a seventh time since early 2018 to free up more funds for lending, days after a cabinet meeting signaled that more policy loosening may be imminent.

August exports fell 1% from a year earlier, the biggest fall since June, when it fell 1.3%, customs data showed on Sunday. Analysts had expected a 2.0% rise in a Reuters poll after July’s 3.3% gain.

That’s despite analyst expectations that a falling yuan would offset some cost pressure and looming tariffs may have prompted some Chinese exporters to bring forward or “front-load” U.S.-bound shipments into August, a trend seen earlier in the trade dispute…..

Among its major trade partners, China’s August exports to the United States fell 16% year-on-year, slowing sharply from a decline of 6.5% in July. Imports from America slumped 22.4%.

Many analysts expect export growth to slow further in coming months, as evidenced by worsening export orders in both official and private factory surveys. More U.S. tariff measures will take effect on Oct. 1 and Dec. 15.

Banks are suffering a liquidity squeeze:

The PBoC says the new cuts will release RMB 900 billion of liquidity. That’s more than the RMB 800 billion and RMB 280 billion released by the January and May cuts, respectively. (Trivium China)

Consumer confidence is ebbing.

Google Searches for Recession

China’s response to tariffs has annoyed the Trump administration, making prospects of a trade deal even more remote.

China’s response to U.S. trade actions appears to reflect a cynicism about the efficacy of democracy. Beijing’s strategy appears calibrated to exploit the fact that the American people elect the head of their government, by attempting to influence how the American people will vote. In effect, it seems to be gambling on its ability to turn American democracy against itself.

At the center of China’s responses are the tit-for-tat tariffs intended to hurt American farmers, a constituency that tends to support President Donald Trump and to live in crucial swing states. These tariffs appear designed to deliver political pain in the U.S., not to produce any economic benefit for China. China’s other political meddling, as Vice President Mike Pence recently laid out, includes attempts at interference in the 2018 U.S. midterm elections. Recent targets of Chinese Communist Party influence campaigns also include state and local governments, Congress, academia, think tanks, and the business community. (The Atlantic)

A massive increase in stimulus is the likely eventual outcome, focused on housing and infrastructure. That would fuel demand for raw materials such as iron and steel.

If not, expect a sharp drop in imports to impact on China’s major trading partners.

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Authority founded on injustice is never of long duration ~ Seneca

Authority founded on injustice is never of long duration.

~ Seneca the Younger (62 AD)

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Gold: Correction likely as Yuan finds support

The Yuan found short-term support at 0.1395/0.1400 against the US Dollar. Expect a rally over the next month, with “talks about talks” between US and Chinese trade representatives.

The Yuan is in a long-term down-trend against the Dollar that shows no signs of easing. Our view is that resolution of trade tensions is unlikely. Trade is merely the tip of the iceberg in a far wider clash between two global powers with conflicting ideologies, likely to continue for decades, if not longer.

CNYUSD

The Yuan rally has softened demand for Gold and breach of support at $1500, or penetration of the rising trendline, would warn of a correction. A correction may present a good entry point in an expected long-term up-trend. Our target is the 2012 high at $1800/ounce.

Spot Gold in USD

Last week’s gravestone candlestick on Silver also warns of a correction. Gold and Silver tend to move in tandem.

Spot Silver in USD

The All Ordinaries Gold Index is testing support at 7500. Breach would warn of another decline, with a target of 6000/6500. The primary trend is expected to remain upward, so again, this may present a good entry point.

All Ordinaries Gold Index

A long-term chart of the Australian Dollar against the greenback illustrates our long-term target of 60 cents (subtract 10 cents (80-70) from 70 cents). A weaker Aussie Dollar would support stronger prices for local gold miners.

Australian Dollar

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Time to be defensive

Bob Doll at Nuveen says he does not expect a recession (for the next few quarters) but remains neutral towards stocks:

“Although stock prices have advanced over the last couple of weeks, investors remain focused on downside economic and policy risks and are increasingly concerned about a possible recession. The latest manufacturing readings hurt economic sentiment, while trade issues, turmoil in Hong Kong, the increasing likelihood of a messy, no-deal Brexit and a downturn in European growth are increasing worries.”

The Institute for Supply Management August Report points to an economic slow-down, with the Purchasing Managers’ Index (PMI) falling to 49.1 percent, from 51.2 percent in July. The New Orders Index also declined, to 47.2 percent from 50.8 percent in July. Readings below 50 indicate contraction.

“…The 2020 U.S. elections linger in the backdrop, offering potential to produce either a dramatic shift in economic policy should the Democrats retake the White House, or continued policy uncertainty should President Trump win reelection.

Against this backdrop, investors are struggling to position their portfolios. Consensus appears to say that it is time to turn more defensive, but U.S. Treasuries and other government bond yields appear to offer little if any value. Indeed, government bond markets are pricing in a high likelihood of a recession and a prolonged period of sluggish growth. At the same time, equity markets have been range bound over the last several months (and, by some measures, since the start of 2018) and are providing unclear signals.

In our view, the preponderance of the evidence suggests that growth will remain sluggish but a recession will be avoided, at least for the next few quarters. In other words, we think the signals coming from the equity markets are more accurate than those coming from government bond markets. Nevertheless, we continue to have a broadly neutral view toward stocks, and think investors should remain selective, focusing on such themes as companies that offer compelling value and those that have the ability to put relatively high levels of free cash flow to work.”

The wild card is the impact that high levels of uncertainty may have on business investment and employment.

Google Searches for Recession

This is a time to be defensive.

Bonds, traditional dividend-paying blue chips, and growth stocks all appear over-priced at current levels. Small caps are high risk in the current volatile environment and we are focused on large cap stocks with strong cash flows and defensible market position in non-cyclical industries. Some cyclical sectors may present value but investors need to be selective because of vulnerability to a potential down-turn.

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S&P 500 buying pressure but payrolls disappoint

August labor stats, released today, point to low real GDP growth for Q3. Growth in weekly hours worked came in at a low 1.09% and GDP is likely to follow.

Real GDP and Hours Worked

While inflation is not the primary concern at the Fed right now, rising annual hourly wage rate growth (3.46% for total private) flags an increase in underlying inflationary pressure. This may make the Fed more hesitant about cutting rates despite Donald Trump’s tweet storm.

Average Hourly Wage Rate

Most important is the continued decline in annual payroll growth. At 1.38% for August, further weakness is likely and a fall below 1.0% would warn of an economic slow-down.

Real GDP and Hours Worked

The S&P 500 is headed for another test of resistance at 3000. The Trend Index oscillating above zero for the last 9 months indicates buying pressure but I expect strong resistance at 3000. Upside is limited while downside risks are expanding.

S&P 500

Semiconductors are doing better than expected, despite the trade war, but I suspect will weaken when the surge in orders ahead of tariffs tails off.

Semiconductors

Retail has stalled since late 2018 and bearish divergence on the Trend Index suggests selling pressure.

Retail

Automobiles, in a decline since 2017, have rallied over the last 6 months. But, again, further weakness is expected.

Automobiles

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.

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