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Some good discussion on our forum regarding current high stock valuations, based more on hopes than on earnings.
This chart of Price-Earnings ratios highlights the problem. PEs for both the MSCI World Index (ex-Australia) and the ASX 200 are close to historic highs (after the Dotcom bubble).
Strong earnings growth would soon fix this but there is little sign of that at present.
From Jens Meyer and Patrick Commins:
A surprise blow-out in the October trade deficit has raised questions about the predicted rebound in economic growth, following the first contraction in GDP in five years.
Instead of shrinking as predicted, Australia’s trade gap widened 20 per cent to $1.54 billion as growth in imports outpaced exports….
Paul Dales from Capital Economics said the October trade number was worrying as it implied net exports – a key GDP component – might be a big drag on economic growth in the fourth quarter, as volumes mattered for real GDP growth.
“This could all change when the November and December trade data are released. But at the moment, other parts of the economy will have to be much stronger to prevent another fall in GDP,” he said, adding that while that was probable, he was nonetheless now more worried about a possible recession.
On its own, the trade deficit is unlikely to tilt the economy into recession but there is a worrying contraction in business investment, outside of the expected mining slow-down, and in wages growth.
Business investment in Australia continues its sharp descent since the end of the mining boom, falling below 14% of GDP for the first time since the Dotcom crash.
Source: RBA Chart Pack
Apart from the expected “cliff” in Engineering, investment in Machinery and Equipment has fallen to record lows.
Source: RBA Chart Pack
Without investment, growth is likely to contract. The impact on Australian wages is an ominous warning.
Source: RBA Chart Pack
From Andrew Hanlan at Westpac:
The Australian economy contracted in the September quarter, with a sharper fall than anticipated.Q3 GDP was -0.5%, after a +0.6%. Annual growth slowed to 1.8% from 3.1%….
From Zac Crellin:
The policies of a Trump administration are both the biggest downside and upside risks to the global economy, an international survey of companies by Oxford Economics has found.
While 38 per cent of respondent companies were hopeful for US growth to surge thanks to President-elect Donald Trump’s fiscal stimulus program, 27 per cent feared Mr Trump would instigate a trade war between the US and China….
Source: Trump the biggest positive and negative risk for growth, survey finds
The ASX 200 rally stalled at 5500. Declining 21-day Twiggs Money Flow indicates rising selling pressure. Breakout above 5500 would complete a bear trap, indicating a primary advance to 5800*. But reversal below 5400 would signal another test of primary support at 5150.
Germany’s DAX is retracing to test support at 10200. The DAX has formed a narrow line (or consolidation) between 10200 and 10800 over the last quarter. Declining Twiggs Money Flow is typical during a consolidation and does not have much significance unless it crosses below zero. Breakout will signal future direction, either an advance to 11500* or a test of support at 9000.
* Target calculation: 10500 + ( 10500 – 9500 ) = 11500
The Footsie (FTSE 100) is again testing support at 6700. Declining Twiggs Money Flow warns of selling pressure. Breach of 6700 is likely and would warn of a correction to 6500.
From Alex Barker:
Some British ministers reckon that Europe will eventually realise there are negative consequences for all sides from a hard, sharp Brexit. One is the competitive threat posed by a UK unbound. Dubbed the “Singapore model”, this is a scenario of British tax and regulatory “dumping” that European capitals fear. Britain is too big, too close and too similar an economy to not worry about being undercut…..
The second is the City of London. This remains Europe’s main financial hub and a hard exit could raise costs for corporate Europe and inflame weaknesses such as Italian banks.
David Davis, Brexit minister, has noted that more EU companies request a financial-services passport to operate in the UK than vice versa….
US stocks are buoyant on hopes that a Donald Trump presidency will benefit business, with major indexes flagging a bull market. But promises come first, the costs come later. While I support a broad infrastructure program and the creation of a level playing field in global markets, the actual execution of these ideas is critical and should not be allowed to be hijacked by the establishment for their own ends.
Erection of trade barriers is a useful negotiating position but is unlikely to be achieved without enormous damage to the global economy. As long as your trading partners think you are crazy enough to do it, they may be more amenable to establishing fair ground rules for international trade. If they don’t believe the threat, they will be happy to continue on their present path. So Trump walks a fine line between reassuring his allies and the domestic market, while keeping others guessing about his intentions.
Before we get carried away with hopes and expectations, however, we need to evaluate the current state of the economy in order to assess the current potential for growth.
Let’s start with the negatives.
Construction spending is slow, at about three-quarters of pre-GFC (and sub-prime) levels. It will take more than an infrastructure program to restore this (though it is a step in the right direction). What is needed is higher growth expectations for the economy.
Industrial production is close to its pre-GFC peak but has been declining since 2014.
Job growth is slowing. Decline below 1.0 percent would be cause for concern.
Rail and freight activity also reflects a slow-down since 2015.
The Philadelphia Fed’s broad-based Leading Index has also softened since 2014. Decline below 1.0 percent would be cause for concern.
One of my favorite indicators, this graph compares profit margins (per unit of gross value added) to employee costs. There is a clear cycle: employee costs (per unit) fall after a recession while profits rise. As the economy recovers and approaches full capacity, employee costs start to rise and profits fall — which leads to the next recession. At present we can clearly see employee costs are rising and profit margins are falling.
It will be difficult for corporations to continue to grow earnings in this environment. Business investment is falling.
Plowing money into stock buybacks rather than into new investment may shore up corporate performance for a while but hurts construction and industrial production. Turning this around is a major challenge facing the new administration.
Retail sales are rising as increased employee compensation costs lift consumer confidence. Solid November sales with strong Black Friday numbers would help lift confidence even further.
Light vehicle sales are also recovering, a key indicator of consumers’ long-term outlook.
Rising sales and infrastructure investment are only part of the solution. What Donald Trump needs to do is prime the pump: introduce a fairer tax system, minimize red tape and reduce political interference in the economy, while enforcing strong regulation of the financial sector. Not an easy task, but achieving these goals would help restore business confidence, revive investment, and set the economy on a sound growth path.
In the short run, the market is a voting machine
but in the long run it is a weighing machine.~ Benjamin Graham: Security Analysis (1934)
