S&P 500 meets resistance while trade talks continue

Trade talks continue, accompanied by reassuring noises from participants. On Wednesday, U.S. Trade Representative Robert Lighthizer will update the House Ways and Mean Committee on progress with China while Donald Trump is away in Hanoi, schmoozing with his new best buddy Kim Jong Un. My guess is that one will prove as intractable as the other. Expect a major announcement in the next few weeks on both fronts but little change on the ground.

Both Kim and Xi play the long game. Trump is focused on next year’s elections and may be tempted to trade short-term gain for long-term pain.

“No matter how many tons of soybeans they buy if China gets to keep cheating & stealing trade secrets it won’t be a good deal for America, our workers or our national security,” Republican Senator Marco Rubio of Florida tweeted on Friday after Agriculture Secretary Sonny Perdue said China offered to buy 10 million tons of soybeans as talks continued.(Bloomberg)

The S&P 500 is testing resistance at 2800. Retreat below 2600 would warn of another decline.

S&P 500

Volatility remains high, however, and a 21-day Volatility trough above 1.0% would signal a bear market.

S&P 500 Volatility

10-Year Treasury yields are testing support at 2.60% and a Trend Index peak below zero warns of buying pressure from investors (yields fall as prices rise). Two factors are driving yields lower: investors seeking safety and the Fed walking back its hawkish stance on interest rates.

10-Year Treasury Yield

It is likely that the bear market will continue for the foreseeable future. The strength of the next correction will confirm or refute this.

Men naturally despise those who court them, but respect those who do not give way to them.

~ Thucydides (460 – 400 B.C.)

Gold-Oil divergence

The crude oil bounce continues but the primary trend is down. WTI Light Crude (shown here on a monthly chart) is likely to test resistance at $60/barrel, followed by another test of primary support at $45.

Crude Oil

Weak crude tends to coincide with a weak gold price. At present the two commodities are diverging, with gold rallying as crude falls. Safe haven demand for gold, due to rising global uncertainty, is the most likely explanation.

Spot Gold and Crude Oil adjusted for inflation (CPI)

Spot Gold is testing resistance at $1350/ounce. Breakout would signal a primary advance but gold is expected to follow oil lower in the long-term.

Spot Gold in USD

The All Ordinaries Gold Index broke resistance at 5400/5500, signaling an advance to 7000. Strength of the advance depends on a weaker Aussie Dollar and/or a stronger gold price in US Dollars.

All Ordinaries Gold Index

ASX 200 buoyant but banks a worry

The Materials sector (18.5% of the ASX 200 index) continues its advance, buoyed by a temporary iron ore shortage and positive spin on US-China trade talks. The higher trough on Twiggs Money Flow below confirms buying pressure.

ASX 200 Materials

ASX 200 Financials (31.4% of the main index) are testing resistance at 5900/6000 but remain in a primary down-trend. Declining house prices are a significant headwind. Respect of resistance would strengthen the bear signal, while breakout would warn that a base is forming.

ASX 200 Financials

The ASX 200 is likely to test the 2018 high at 6350 but remains in a bear market. Another test of the former primary support level, at 5650, is likely. A higher trough, at that level, would reverse the down-trend.

ASX 200

I am cautious on Australian banks and hold more than 40% in cash and fixed interest investments in the Australian Growth portfolio.

Gold rallies but so does the Dollar

A long-term (monthly) chart shows Crude Oil (WTI Light Crude) has broken below its trend channel and is testing support at $45/barrel.

Crude Oil

Weak crude tends to coincide with a strong Dollar. Breakout of the Dollar index above 97 is likely. Rising Trend index troughs indicate buying pressure.

Dollar Index

Gold is headed for another test of resistance at $1350/ounce but a strong Dollar is likely to undermine a primary advance.

Spot Gold in USD

The All Ordinaries Gold Index broke resistance at 5400/5500, signaling a primary advance with a target of 7000. That will depend on further weakness in the Aussie Dollar and/or a stronger gold price.

All Ordinaries Gold Index

Conclusion: We are witnessing a rally in Gold due to global uncertainty but the LT outlook, with declining crude and a stronger Dollar, is still bearish.

Retail sales fall while trade talks stall

Retail sales

Retail sales growth (USA advance retail sales excluding autos and parts) fell sharply in December, indicating that consumer confidence is fading despite strong employment figures.

Advance Retail Sales

The decline in consumer confidence also shows in lower January 2019 light vehicle sales.

Light Vehicle Sales

Trade talks make little progress

Trivium provide a useful update on US-China trade negotiations:

The latest round of trade talks with the US are finishing up as we go to press. There hasn’t been much progress (Bloomberg): “As of Friday afternoon, there had been no visible progress on efforts to narrow the gap around structural reforms to China’s economy that the U.S. has requested, according to three U.S. and Chinese officials who asked not to be identified because the talks were private……Chinese officials are angry about what they see as US efforts to undermine their state-led economy.”

These are issues that will take generations to resolve. The chance of a quick fix is highly unlikely.

Stocks

The stock market continues to rally on the back of a solid earnings season.

Of the 216 issues (505 in the S&P 500 index) with full operating comparative data 154 (71.3%) beat, 51 (23.6%) missed, and 11 met their estimates; 135 of 215 (62.8%) beat on sales. (S&P Dow Jones Indices)

Index volatility remains high, however, and a 21-day Volatility trough above 1.0% would warn of a bear market. S&P 500 retreat below 2600 would reinforce the signal.

S&P 500

Crude prices continue to warn of a fall in global demand.

Light Crude

As do commodity prices.

DJ-UBS Commodities Index

10-Year Treasury yields are testing support at 2.50% and a Trend Index peak below zero warns of buying pressure from investors seeking safety (yields fall as prices rise).

10-Year Treasury Yield

The Nasdaq 100 shows rising Money Flow but I believe this is secondary in nature. The next correction is likely to provide a clearer picture.

Nasdaq 100

My conclusion is the same as last week. This is a bear market. Recovery hinges on an unlikely resolution of the US-China ‘trade dispute’.

Concessions to adversaries only end in self reproach, and the more strictly they are avoided the greater will be the chance of security.

~ Thucydides (460 – 400 B.C.)

ASX 200 enjoys iron ore spike

The ASX 200 has been buoyed by a temporary spike in iron ore prices. Materials (comprising 18.5% of the main index) broke through resistance at 12500, signaling a primary advance. A higher trough on Twiggs Money Flow indicates buying pressure.

ASX 200 Materials

The ASX 200 encountered resistance at 6100 but the rally could go so far as to test the 2018 high of 6350. We remain in a bear market. Only a correction that successfully forms a higher trough would reverse that. Expect another test of the former primary support level at 5650.

ASX 200

Financials, the largest ASX 200 sector (31.4%), remains in a primary down-trend. Declining house prices are likely to drag the index lower. Respect of resistance at 5900 would strengthen the bear signal, while breach of 5300 would signal another decline.

ASX 200 Financials

I have been cautious on Australian stocks, especially banks, for a while, and hold more than 40% in cash and fixed interest investments in the Australian Growth portfolio.

Apple Inc. (AAPL)

Apple (AAPL) is a notable omission in my international model portfolio. There are several reasons.

First, sales growth has been declining for several years.

Apple Revenue Growth (AAPL)

Second, Apple is vulnerable if there is a US-China trade war. Greater China represents almost 25% of projected sales and imposition of tariffs or other trade barriers could hurt Apple. But, even without trade barriers, sales in China are already slowing.

“While we anticipated some challenges in key emerging markets, we did not foresee the magnitude of the economic deceleration, particularly in Greater China. In fact, most of our revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline, occurred in Greater China across iPhone, Mac and iPad…” (Tim Cook, January 2 letter to shareholders)

Third, Apple is losing market share in China as local smartphone technology improves. From The Wall Street Journal:

Apple’s share of the Chinese smartphone market has been shrinking, crowded out by tech giants such as China’s Huawei Technologies Co. that market increasingly sophisticated phones at a lower price tag.

 

Apple’s share of the Chinese smartphone market contracted to 7.8% in the first three quarters of 2018 from a peak in 2015 of 12.5%, according to Canalys, a market research firm.

Fourth, Apple is testing primary support at $150 on the long-term chart. Bearish divergence on Twiggs Money Flow warns of selling pressure; a peak at zero would strengthen the signal. Respect of resistance at $180 would also be bearish, while breach of support at $150 would confirm a primary down-trend.

Apple (AAPL)

Last, Apple is trading at a Consensus Forward P/E of 14.8 (Morningstar, February 12, 2019) which equates to an estimated LT growth rate of 10% at 12.5% p.a. rate of return. Given the current sales outlook, that seems optimistic.

 

Why the RBA shouldn’t cut interest rates

There are growing cries in local media for the RBA to cut interest rates in order to avoid a recession. House prices are falling and shrinking finance commitments point to further price falls. Declining housing values are likely to lead to a negative wealth effect, with falling consumption as household savings increase. Employment is also expected to weaken as household construction falls. Respected economist Gerard Minack thinks “a recession in Australia is becoming more likely”.

The threat should not be taken lightly, but is cutting interest rates the correct response?

Let’s examine the origins of our predicament.

A sharp rise in commodity prices in 2004 to 2008.

Commodity Prices

Led to a massive spike in the Trade-weighted Index.

Australia Trade Weighted Index

And a serious case of Dutch Disease: the destructive effect that offshore investment in large primary sector projects (such as the 1959 Groningen natural gas fields in the Netherands) can have on the manufacturing sector.

Business investment in Australian has fallen precipitously since 2013.

Australia Business Investment

With wages growth in tow.

Wages Index

Instead of addressing the underlying cause (Dutch Disease), Australia tried to alleviate the pain by stimulating the housing market. Housing construction boosted employment and the banks were only to happy to accommodate the accelerating demand for credit.

Leading Index

But house prices have to keep growing and banks have to keep lending else the giant Ponzi scheme unwinds. When house prices and construction slows, the economy is susceptible to a severe backlash as Gerard Minack pointed out.

How to fix this?

The worst response IMO would be to pour more gasoline on the fire: cut interest rates and reignite the housing bubble. Low interest rates have done little to stimulate business investment over the last five years, so further cuts are unlikely to help.

The only long-term solution is to lift business investment which creates secure long-term employment. To me there are three pillars necessary to achieve this:

  1. Accelerated tax write-offs for new business investment;
  2. Infrastructure investment in transport and communications projects that deliver long-term productivity gains; and
  3. A weaker Australian Dollar.

Corporate tax write-offs

Accelerated corporate tax write-offs were a critical element of the US economic recovery under Barack Obama. They encourage business to bring forward planned investment spending, stimulating job creation.

Infrastructure

Government and private infrastructure spending is important to fill the hole left by falling consumption. But this must be productive investment that generates a market-related return on investment. Else you create further debt with no income streams to service the interest and capital repayments.

A weaker Australian Dollar

Norway is probably the best example of how an economy can combat Dutch Disease. They successfully weathered an oil-driven boom in the 1990s, protecting local industry while establishing a sovereign wealth fund that is the envy of its peers. Their fiscal discipline set an example to be followed by any resource-rich country looking to navigate a sustainable path through a commodities boom.

In Australia’s case that would be closing the gate after the horse has bolted. The benefits of the boom have long since been squandered. But we can still protect what is left of our manufacturing sector, and stimulate new investment, with a weaker exchange rate.

I doubt that the three steps are sufficient to avert a recession. But the same is true of further interest rate cuts. And at least we would be addressing the root cause of the problem, rather than encouraging further malinvestment in an unsustainable housing bubble.

More signs of risk avoidance

Bloomberg: “U.S. stocks slid as investors grew anxious that the Trump administration won’t reach a trade deal with China before a March deadline for escalating the war. Treasuries surged.

The post-Christmas rally that added 16 percent to the S&P 500 came under increasing pressure amid reports the two trading partners remained far apart on a deal and that the nations’ presidents won’t meet before higher tariffs are slated to take effect on Chinese goods next month.”

S&P 500 volatility remains high. If the rally runs out of steam, a large Twiggs Volatility (21-day) trough above 1.0% would signal a bear market. Retreat below 2600 would reinforce the signal.

S&P 500

Crude prices retreated below resistance at $54/$55 per barrel, on fears of falling global (mainly Chinese) demand. Another test of primary support at $42/barrel is likely.

Light Crude

10-Year Treasury yields retreated to 2.65%. A Trend Index peak below zero warns of buying pressure from investors (yields fall when prices rise) who are looking for safety.

10-Year Treasury Yield

My conclusion is the same as last week. This is a bear market. Recovery hinges on an unlikely resolution of the US-China ‘trade dispute’.

The secret of happiness is freedom and the secret of freedom is courage.

~ Thucydides (460 – 400 B.C.)

ASX 200 spikes but will it last?

The reason for the upward spike in the ASX 200 is clear. While shortage in iron ore supply may be temporary, while Brazil reviews mine safety, it is sufficient to cause spot prices to jump 20% in the last week.

Iron Ore

Windfall profits are likely to benefit not only the Materials sector but the entire economy over the next few months. The ASX 200 Materials Index ran into resistance at 12500 while a bearish divergence on Money Flow continues to warn of selling pressure.

ASX 200 Materials

The ASX 200 broke resistance at 6000 but remains in a bear market. Reversal below 5650 would signal a primary decline, with a target of the 2016 low at 4700.

ASX 200

ASX 200 Financials Index rallied on release of the Royal Commission on Banking final report. The outcome could have been a lot worse, or so the market seems to think.

ASX 200 Financials

I suspect the bank rally will be short-lived. Credit growth is falling and broad money warns of further contraction.

Australia Credit and Broad Money Growth

House prices are falling and concerns over a slowing economy have caused many to call for further rate cuts. I believe this is short-sighted.

Australia House Prices and Household Debt

One of the biggest threats facing the economy is ballooning household debt. Tighter credit and falling house prices are likely to curb debt growth….provided the RBA doesn’t pour more gasoline on the fire.

I have been cautious on Australian stocks, especially banks, for a while, and hold more than 40% in cash and fixed interest investments in the Australian Growth portfolio.