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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Tearing Teslas apart to reveal some of their best and worst decisions

Tesla has a few problems to sort out before it makes our shortlist.

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Nasdaq warns of broad market correction

Tech stocks fell sharply, with the Nasdaq 100 closing below support at 7400, warning of a correction. Twiggs Money Flow (21-day) cross below zero indicates medium-term selling pressure. Follow-through of the index below 7300 would signal a correction to test 7000.

Nasdaq 100

The S&P 500 has so far respected support at 2870. Breach would confirm  a broad market correction and test the rising LT trendline at 2800.

S&P 500

Asia

In China, the Shanghai Composite Index is headed for another test of primary support at 2650. Trend Index peaks at/below zero indicate long-term selling pressure. Breach of 2650 would offer a long-term target of 2000, the 2014 low.

Shanghai Composite Index

India’s Nifty is undergoing a strong correction. Breach of support at 10,000 would warn of a primary down-trend.

Nifty Index

Europe

Dow Jones Euro Stoxx 50 is again testing primary support at 3300. A Trend Index peak at zero warns of mounting selling pressure. Breach of 3300 would warn of a primary decline, with a target of 3000.

DJ Euro Stoxx 600 Index

The Footsie is also testing primary support, at 7250, but a recovering Trend Index indicates buying pressure.

FTSE 100 Index

Rising US interest rates are already hurting developing economies like India and China, and a looming US-China trade war would threaten a global contraction.

Only when the tide goes out do you discover who’s been swimming naked.

~ Warren Buffett

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ASX 200 correction

The ASX 200 broke support at 6120/6150, signaling a correction. Expect support at the rising long-term trendline at 6000. Penetration of the trendline would warn that the primary up-trend is faltering.

ASX 200

Banks lead the decline, with ASX 300 Banks index headed for a test of primary support at 7300. A Trend Index peak below zero would warn of strong selling pressure. Breach of 7300 would signal another decline. Follow-through below 7000 would present a long-term target of 5000, the 2011 low.

ASX 300 Banks Index

I am cautious on Australian stocks, especially banks, and hold over 30% cash in the Australian Growth portfolio.

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NEXTDC Limited (NXT)

Stock: NEXTDC Limited
Symbol: NXT
Exchange: ASX
Latest Price: $6.13
Market cap: $2.1 billion
Currency: AUD
Financial Year: 30 June
Date: 8 October 2018

Sector: Technology
Industry: Data Storage

Investment Theme: Long-term Growth
Structural Trends: Rising connectivity and online services

Company Profile

NEXTDC is an Australia-based and Australia-focused technology company providing data center outsourcing solutions through a nationwide network of Tier III and Tier IV facilities.

Markets & Competitors

NEXTDC provides enterprise-class colocation services to local and international organizations. Clients include:

  • Government agencies and private enterprise concerned as to whether off-shore data storage meets Australian Privacy Act and/or requirements for the protection of sensitive information;
  • Global cloud providers such as Google, Amazon, Microsoft, IBM and Oracle;
  • Large IT service providers such as Wipro, Tech Mahindra, NEC, Dimension Data, Fujitsu, NTT and Data#3; and
  • Telecommunications providers such as Optus, Telstra, AAPT, Vocus, TPG, PCCW, Superloop and CenturyLink.

Financial performance

Revenue Growth

NEXTDC shows steady revenue growth over the past 5 years as it expands its data centers across Australia.

Revenue per share

Net assets expanded to $1.2 billion in FY 18 from $282 million in FY15, funded by a mix of new equity and debt. Further expansion is planned for FY19:

NEXTDC recently announced plans to acquire three new sites in Australia for additional data centres in Sydney, Melbourne and Perth: S3 80MW, M3 80MW and P2 20MW – these new facilities in Sydney and Melbourne will be the largest ever built in Australia. That takes NEXTDC’s total future capacity to over 300MW.

Return on Assets/Equity

While revenue growth may appeal, return on assets is low at 0.64% in FY18 (FY17: 3.33%*). Return on equity is not much better at 0.95% for FY18 (FY17: 5.48%*). EBITDA/Total assets fell to 5.06% in FY18, from 5.75% in FY17.

Return on Equity and Return on Assets

Utility Origin Energy (ORG) earns similar rates of return at 0.88% (ROA), 1.88% (ROE) and 11.9% (EBITDA/TA).

*FY17 results were inflated by a $10.2 million tax credit.

Weaknesses

Development of new and existing data centers is capital intensive and sometimes undertaken without pre-sales commitment from customers, and there is a risk that there is not enough demand to achieve a sufficient return on investment.

According to various recent industry cyber risk reports, cyber incidents and their financial impacts are increasing significantly year on year and cyber criminals are targeting small and large businesses alike. To mitigate these risks, NEXTDC has implemented an information security management system based on ISO 27001 as well as undertaken ongoing penetration and vulnerability tests.

Catastrophic failure or equipment malfunction at a data center could result in NEXTDC not being able to provide power and cooling to support customers’ equipment, thus breaching service agreements and incurring contractual liabilities. To address this risk, NEXTDC’s data centers are designed and built with significant redundancy in place.

Technical Analysis

Twiggs Momentum has declined to a still-respectable 67% but 50-week Trend Index crossed below zero after a bearish divergence, warning of strong selling pressure.

Twiggs Momentum and Trend Index (50 week)

Conclusion

Do not buy. NEXTDC earns utility-level rates of return on assets and does not justify its current high forward price-earnings multiple of 78. Long-term revenue growth will require significant investment in new data centers, funded in part by new equity issues which dilute returns to existing shareholders.

Disclosure

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

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Dollar strength keeps gold bulls in check

Gold continues to find resistance at $1210/ounce. Trend Index peaks below zero warn of LT selling pressure but rising troughs suggest a secondary rally. Respect of resistance and the declining trendline would warn of another decline, offering a long-term target of the 2015 low at $1050/ounce.

Spot Gold in USD

The Dollar Index found support at 94. Follow-through above 96.50 would confirm another advance. A strengthening Dollar is likely to weaken demand for Gold.

Dollar Index

The Aussie Dollar broke support at 71 US cents, prompting a weak rally among Australian gold miners. The All Ordinaries Gold Index (XGD) is ranging between 4550 and 4900. Gold is more volatile than the currency and likely to determine long-term direction. A Trend Index peak below zero would signal continuation of the down-trend.

All Ordinaries Gold Index

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Extraordinary times of low unemployment and low inflation

Unemployment fell to 3.7% for September, well below the long-term natural rate of unemployment. This normally signifies a tightening labor market, a precursor to higher inflation.

Unemployment and the Natural Rate

But growth in average hourly earnings dipped slightly, to 2.75% for the past 12 months. Underlying inflationary forces remain subdued.

Average Wage Rates

As Fed Chairman Powell suggested, the Fed may be overestimating the natural rate. In his speech on Tuesday Powell summed up the current situation:

…Many of us have been looking back recently on the decade that has passed since the depths of the financial crisis. In light of that experience, I am glad to be able to stand here and say that the economy is strong, unemployment is near 50-year lows, and inflation is roughly at our 2 percent objective. The baseline outlook of forecasters inside and outside the Fed is for more of the same.

This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.

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ASX 200: Miners rally but banks a worry

The ASX 200 found support at 6120/6150, with a long tail indicating buying interest. Follow-through above 6250 would suggest another advance. Breach is now unlikely but would warn of a test of the rising long-term trendline at 6000.

ASX 200

A rally on resources stocks helped support the overall index. Expect the ASX 300 Metals & Mining index to test 4000.

ASX 300 Metals & Mining

Miners were helped by a weakening Aussie Dollar. Breach of support at 71 US cents offers a target of 69 cents. Trend Index peaks below zero warn of strong selling pressure.

AUDUSD

Banks, on the other hand, are weakening. The ASX 300 Banks index  broke support at 7700, with a declining Trend Index warning of selling pressure. Expect a test of primary support at 7300.

ASX 300 Banks Index

Falling broad money and credit growth warn of a contraction — unless an unlikely Chinese-led mining boom can keep the wolf from the door.

Broad Money and Credit Growth

House prices are falling.

House Prices

Returns on bank equity are declining due to increased capital requirements, lower credit growth and narrow margins.

Banks Return on Equity

I remain cautious on Australian stocks, holding over 30% cash in the Australian Growth portfolio.

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It’s a bull market

The US economy continues to show signs of a robust expansion. Net capital formation is rising (as a percentage of GDP) as it is wont to do during a boom. In layman’s terms net capital formation is the net growth in physical assets used in the production of goods and services, after allowing for depreciation.

Net Capital Formation

The Wicksell spread has turned positive. When return on investment (we use nominal GDP growth as a surrogate) exceeds the cost of capital (reflected by low investment grade Baa bond yields) that encourages new investment and economic expansion as in the 1960 – 1980 period on the chart below.

Wicksell Spread

Real bond yields, reflected below by Baa yields minus core CPI (blue line) on the chart below, are also near record lows. Low real returns on bonds support high stock earnings multiples.

Real Bond Yields

Fed Chairman Powell summed up the situation in a speech on Tuesday this week:

…Many of us have been looking back recently on the decade that has passed since the depths of the financial crisis. In light of that experience, I am glad to be able to stand here and say that the economy is strong, unemployment is near 50-year lows, and inflation is roughly at our 2 percent objective. The baseline outlook of forecasters inside and outside the Fed is for more of the same.

This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.

The biggest risk is that investors get carried away and drive earnings multiples sky high, but gradual rate increases from the Fed and the threat of tariff wars appear to be keeping animal spirits in check.

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S&P 500 cracks trendline

The S&P 500 penetrated its secondary trendline, indicating a correction to test support at the LT trendline at 2800. Shorter-term 21-day Twiggs Money Flow crossed below zero to warn of a secondary correction. Follow-through below the January high at 2870 would confirm.

S&P 500

Nasdaq 100 breach of 7400 would also confirm, signaling a correction to test support at 7000.

Nasdaq 100

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Treasury yields confirm bond bear market

10-Year Treasury yields respected their new support level at 3.00%, confirming a primary advance.

10-year Treasury Yield

Breakout above 3.00% also completes a double-bottom reversal, signaling the end of a three-decade-long secular bull market in bonds.

LT 10-year Treasury Yield

The yield differential between 10-year and 3-month Treasuries is declining but a flat yield curve does not warn of a recession. Only if the yield differential crosses below zero, with short-term yields rising faster than long-term, will there be a recession warning.

Real returns on long-term bonds — the gap between the green and blue lines below — remain near record lows.

1981 to 2018: 10-Year Treasury Yields and GDP Implicit Price Deflator

Only if the gap widens (real returns rise significantly) are we likely to see downward pressure on stock valuations, with falling price-earnings multiples.

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