The ASX 200 is testing primary support at 5200. Decline of Twiggs Money Flow below zero, following a large bearish divergence, warns of strong long-term selling pressure. Breach of support would signal a primary down-trend with an immediate target of 4750.
Bond spreads are an important indicator of risk in financial markets. When corporate bond yields are at a substantial premium to Treasury yields, that indicates higher default risk among large corporations. The graph below, from the RBA chart pack, shows the premium charged for AA-rated corporations compared to US Treasuries. Anything over 150 basis points (bps) indicates elevated risk. For lower-rated BBB corporations, a spread greater than 300 bps is cause for concern. At present, both credit spreads are trending lower, suggesting that financial risk is easing.
Australia displays a similar picture, with AA-rated spreads trending lower. BBB spreads are also falling but remain high at 200 bps relative to 150 bps in the US, reflecting Australia’s vulnerability to commodities and real estate (both here and in China).
US Treasury yields are rising, with the 10-year yield breaking through 1.80 percent to signal a test of 2.0 percent. Further rises are likely on the back of stronger GDP figures for the last quarter.
The Chinese Yuan continues to depreciate against the Dollar in anticipation of another rate rise from the Fed.
Spot gold displays a weak retracement off support at $1250/ounce, with short candles indicating a lack of conviction. Another primary decline is likely and would test primary support at $1200.
The ASX All Ordinaries Gold Index respected the descending trendline, suggesting another decline. Reversal below 4300 would confirm, offering a target of 4000.
Earlier this week I wrote:
“The ASX 300 Banks Index broke through resistance at 8000. Twiggs Money Flow is still negative but recovery above zero now looks likely. Breakout would signal an advance to 8700 but I remain cautious and would wait for a retracement to respect the new support level.”
The picture changed within 24 hours. Breakout transformed into a false break, reversing below the 8000 support level. Twiggs Money Flow turned down and now recovery above zero looks unlikely.
Trading breakouts is like picking up pennies in front of a bulldozer. Especially when fundamentals offer scant support. I have never done an accurate count, but for every successful breakout there must me at least five, if not ten, false breaks and/or bull or bear traps. Not good odds if you want to preserve your capital. Far better to wait for confirmation, even if that means a higher entry price.
Selling pressure on gold continues, with the SPDR Gold [GLD] ETF consolidating in a bearish narrow band above support at 119. Twiggs Money Flow below zero warns of long-term selling pressure. Continuation of the down-trend is likely and breach of 119 would signal another decline.
Spot gold displays a similar narrow consolidation at $1250/ounce. Continuation is likely and would test primary support at $1200.
The ASX All Ordinaries Gold Index recovered above resistance at 4500 but has so far respected the descending trendline. Respect is likely and reversal below 4300 would signal a decline to 4000.
From Andrew Hanlan at Westpac:
Total real infrastructure activity contracted by almost 10% in the June quarter 2016, to be 26% below the level of a year ago. That was the fourth year of contraction…..
Infrastructure construction work is declining rapidly. First, we had the end of the mining boom as existing projects reached completion while demand, mainly from China, contracted. This was followed by falling demand in the oil & gas sector, ending the development boom in that sector. If you think the apartment boom — driven by investor demand from China — is going to fill the hole, think again.
Financial Stability Snapshot 14 October 2016
Download the complete Snapshot 174KB Financial Stability Snapshot
Correction to my earlier post. Equal-weighted indices don’t always outperform cap-weighted indices, as with the S&P 500. Australia’s ASX 100 Equal Weighted Index underperformed the cap-weighted ASX 100, recording annual growth of 3.79% (EWI) compared to 5.28% for the ASX 100 on a total return basis over the last 10 years.
Canada’s TSX 60 Equal Weighted Index, on the other hand, mimics the S&P 500. Equal Weight achieved an returns of 6.17% over the last 10 years compared to 5.33% for the cap-weighted index.
I will investigate further why Australia bucks the trend but I suspect the banks play a major role. The ASX 300 Banks Index substantially outperforms the broad ASX 300 Index.
From James Kirby at The Australian:
Australia’s big fund managers are now openly bagging index funds and exchange traded funds (ETFs)….Keep away from index funds and ETFs, they cry, the market is too tough for investors to blindly follow an index-style fund when returns are as modest as we have seen in recent times….
But rather than flinging mud back at the active managers…. the passive brigade has instead made two killer moves.
The first move is to reveal quite plainly how the active managers are performing — and they are performing dismally.
The second move is to continually cut prices — or fees — to the point that active managers look very expensive indeed.
Dow Jones’ Indices versus Active Australia Scorecard:
Australian General Equity (Large-Cap) Funds
59.7% underperformed the S&P/ASX 200 Index over one year
69.2% underperformed the benchmark in a five-year period
International Equity General
80.7% underperformed the S&P Developed ex-Australia Large Cap Index in a one-year period
91.9% underperformed the benchmark in a five-year period
I have two major concerns with index funds:
First, index funds reward size, not performance. The bigger a corporation grows, and the bigger its weighting in the index, the more stock an index fund will buy. Over time the index is likely to grow increasingly dominated by a herd of dinosaurs — earning low returns on a large asset pool and unable/unlikely to adapt to change — headed for extinction.
Second, active fund managers perform a valuable role for the entire market, conducting in-depth research of industries, visiting companies and evaluating prospects and performance. Their resulting purchases and sales inform the entire market as to prospective value and under-pin long-term market value. Increasing dominance of passive index funds erodes this capability and will hasten the growth of my first concern.
An easy way to counter the first concern is to invest in equal-weighted index funds. These do not reward size, instead investing an equal amount in each stock in the index instead of weighting by market capitalization.
Apart from eliminating the size bias, the equal-weighted index has another major advantage. It out-performs cap-weighted indices by a sizable margin. The graph below shows the S&P 500 Equal-Weighted Index achieved an annual performance of 8.53% compared to 7.03% for the regular S&P 500 Index, over the last 10 years.
The only way to address the second concern is to keep a sizable part of your portfolio with active managers. Don’t blindly follow performance — last year’s winners are often this year’s losers — but follow managers with reasonable fees and proven long-term ability to outperform the index.
Two short weekly candlesticks suggest the ASX 200 rally has stalled at 5500. Bearish divergence on Twiggs Money Flow warns of selling pressure. Reversal below the lower trend channel would warn of a test of primary support at 5000/5100. Breakout above 5600 is unlikely.
The ASX 300 Banks Index is testing resistance at 8000. Declining Twiggs Money Flow still warns of selling pressure. Breakout above 8000 would signal a primary up-trend but I would be cautious and wait for retracement to respect the new support level. There are some good fundamental reasons, like the real estate/apartment bubble, that suggest a reversal would be premature.
