Category: Banks & Interest Rates

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ASX 200 tests support

The ASX 200 retreated from resistance at the high of 7600 and is now testing support at 7400. Breach would warn of a correction to test primary support at 6750.

ASX 200

The Financials Index has similarly retreated from resistance at 6800. Reversal below 6650 would warn of a correction.

ASX 200 Financials

The A-REIT Index would likewise warn of a correction to test 1200 if support at 1440 is breached. The recent rally was in response to falling long-term bond yields.

ASX 200 REITs

The correction in yields is secondary in nature and is unlikely to reverse the long-term up-trend. Further increases in long-term yields are expected to weaken A-REITs.

10-Year AGB Yield

Healthcare also rallied strongly in the past two months but could reverse if long-term bond yields strengthen.

ASX 200 Healthcare

Consumer Staples are in a strong down-trend. Breach of support at 11500 would warn of another decline.

ASX 200 Staples

Discretionary has surprised to the upside, breaking resistance at 3200. A Trend Index trough at zero indicates buying pressure. Retracement that respects the new support level would signal a further advance.

ASX 200 Discretionary

Energy rallied to test resistance at 11000 but a Trend Index peak below zero warns of selling pressure. Another test of primary support at 10000 is likely.

ASX 200 Energy

The All Ordinaries Gold Index fell sharply as the US Dollar strengthened. Follow-through below 6500 would warn of another test of support at 6000.

All Ordinaries Gold Index

The ASX 300 Metals & Mining Index is falling sharply as China’s recovery falters. Another test of primary support at 5600 is likely.

ASX 300 Metals & Mining

China

Rate cuts and measures to stimulate the Chinese economy have been modest as the PBOC is trying to protect the Yuan from further depreciation against the US Dollar.

ASX 200 Discretionary

The result is slowing growth and deflation as weak demand persists.

China & India Inflation

Conclusion

Falling long-term bond yields have boosted Financials, REITs, Health Care and Consumer Discretionary sectors but the correction in yields is secondary and we expect this to reverse in 2024.

The Metals & Mining sector is falling sharply as China struggles to overcome weak demand while at the same time protecting the Yuan from further depreciation against the Dollar.

Our overall outlook for the ASX 200 remains bearish. Breach of support at 7400 would warn of a correction to test primary support from the October 2022 low at 6750.

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Santa rally: Monetary easing offsets China woes

China’s economy is struggling despite injection of moderate stimulus and efforts to support a collapsing real estate sector. Shrinking demand from China threatens a global economic contraction. G7 central banks have responded with monetary easing, causing a broad rally in stocks. This is most likely a bear market rally, with far shorter duration than a bull market.

China’s Shanghai Composite Index is testing primary support at 2900, warning of an economic contraction. The Trend Index peak near zero confirms selling pressure.

Shanghai Composite

Copper, however, has penetrated its descending trendline. Follow-through above 8500 would test resistance at $8750 per metric ton, threatening a wide double-bottom reversal with a target of $9500. Breakout above $8750 would signal global economic recovery, while reversal below $7800 would warn of a global recession.

Copper

US Stocks

The S&P 500 is testing it 2022 high at 4800, buoyed by injections of liquidity into financial markets.

S&P 500

The equal-weighted S&P 500 broke resistance at 6300, suggesting a broader rally than just the top 7 stocks. Retracement that respects the new support level would confirm the target at 6665.

S&P 500 Equal-Weighted Index ($IQX)

The Russell 2000 small caps ETF (IWM) threatens a similar breakout above 200, offering a target of 240. Breakout would confirm that investors are growing more aggressive (risk-on) and downplaying risks.

Russell 2000 Small Caps ETF (IWM)

Interest Rates

Ten-year Treasury yields are retracing to test resistance at 3.9% or 4.0%; respect is likely and would confirm the target of 3.5%.

10-Year Treasury Yield
An increase in supply of Treasury Notes will test bulls’ conviction next week:

A raft of fresh, post-Christmas government bond supply will put that comprehensive bullishness to the test. Next week, Treasury will auction $57 billion, $58 billion and $40 billion in two-, five- and seven-year notes, respectively. That’s up 20%, 15% and 7% from their average sizes over the past four monthly auctions. (Grant’s Current Yield)

The 2-year Treasury yield (purple below) is falling in anticipation of Fed rate cuts next year. A peak in the 2-year tends to lead the first rate cuts by 6 to 9 months. The signal misfired with the SVB banks crisis in March but the October peak warns of Fed rate cuts in Q2 or Q3 of 2024.
Fed Funds Rate Minimum Target & 2-Year Treasury Yield

International Stocks

The FTSE 100 is testing resistance at 7700, with a Trend Index trough at zero signaling buying pressure.

FTSE 100

The DJ Stoxx Euro 600 — reflecting the top 600 stocks in Europe — broke resistance at 470. Follow-through above 480 would test the 2022 high of 494.

DJ Euro Stoxx 600

Japan’s Nikkei 225 is testing long-term resistance at 33750. Breakout would signal a fresh primary advance but declining Trend Index peaks show a lack of commitment from buyers.

Nikkei 225 Index

The ASX 200 is testing resistance at 7600, buoyed by strong iron ore prices and falling long-term bond yields. A sharp rise in the Trend Index indicates buying pressure but reversal below 7400 would warn of a correction to test support at 7000.

ASX 200

Gold & the Dollar

The US Dollar Index respected resistance at 102.50, confirming the target at 100. Trend Index peaks below zero signal strong selling pressure.

Dollar Index

Gold broke through resistance at $2050, closing at $2053 per ounce. Expect retracement to test the new support level; respect would confirm another attempt at $2100. A falling Dollar and increased bullion demand from central banks is expected to maintain upward pressure on Gold prices.

Spot Gold

Conclusion

Stocks are rallying in response to falling long-term Treasury yields and in anticipation of Fed rate cuts next year. But falling LT Treasury yields is a medium-term rally in a long-term bear market, with LT yields expected to rise in 2025. Fed rate cuts are also a bearish sign, normally preceding a recession by several quarters — falling earnings are definitely not bullish for stocks.

Investors will need to be agile, to take advantage of the current bullishness in stocks while guarding against:

  • a trend reversal in long-term yields; and
  • signs that the broad economy is falling into recession.

Vacation

This is our last newsletter of the year as we close our office for two weeks over Christmas and the New Year.

We wish all our readers peace and goodwill over the festive season and hope for a less tumultuous year ahead.

The Magpie by Claude Monet

The Magpie by Claude Monet

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Dovish Fed, Dollar falls, Gold climbs

Long-term Treasury yields plunged in response to a dovish Fed meeting which kept rates on hold, with a target range of 5.25% – 5.00%. Ten-year Treasury yields are now testing our target at 4.0%.

10-Year Treasury Yield

Declining inflation and signs of labor market easing moved the FOMC to discard the additional rate hike and increase projected rate cuts to 75 basis points next year. Their dot plot now shows 2024 ending with a target range of 4.5% – 4.75%.

10-Year Treasury Yield

Unemployment is forecast to rise to 4.1%, from 3.8% at the end of 2023, but still close to full employment. PCE inflation is projected to slow from 2.8% at the end of ’23 to 2.4% by the end of ’24, with real GDP growth slowing from 2.6% in 2023 to 1.4% next year.

QT continues unchanged at the rate of $95 billion per month: $60 billion Treasuries and $35 billion MBS.

The S&P 500 closed at 4707, headed for a test of its previous high at 4800. Breakout would signal a primary advance, with a target of 5500.

S&P 500

The equal-weighted S&P 500 ($IQX) also rallied strongly, testing medium-term resistance at 6300, compared to the early 2022 high of 6665.

S&P 500 Equal-Weighted Index

Large caps show plenty of buyer interest but the Russell 2000 small caps ETF lags far behind. Normally small caps lead in the first stage of a bull market, so this warns that investors are more risk-averse than in a typical bull market.

Russell 2000 Small Caps ETF (IWM)

Gold & the Dollar

The Dollar weakened, as no doubt intended. Breach of support at 102.50 would offer a target of 100.

Dollar Index

Gold jumped to $2031 per troy ounce. Recovery above $2000 signals another test of resistance at the earlier close of $2070. Dollar Index breach of support at 102.50 would be likely to push Gold above $2070, confirming the medium-term target of $2250 per ounce.

Spot Gold

Conclusion

The bull-trend in stocks, bonds and Gold continues. Breakout to new highs on the S&P 500 and Gold are likely. But beware that the bullish outlook is built on an unstable foundation, with commodities warning of a global recession and record-high federal debt-to-GDP limiting Fed options if the Treasury market is threatened by large outflows.

Acknowledgements

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10-Year Treasury yields rally, Dollar surges

Ten-year Treasury yields tested support at 4.25% yesterday before rallying to 4.35%. Breakout above 4.35% would suggest a stronger move to test 4.50%.

10-Year Treasury Yield

The Dollar index surged in response and is likely to test resistance at 103.

Dollar Index

Gold weakened slightly, to $2040 per ounce.

Spot Gold

Long-term View

Jim Bianco thinks we are headed for 5.5% yield on 10-Year Treasuries by mid-2024. He says that the 10-year yield should match nominal GDP growth:

  • No recession next year
  • Inflation bottoms around 3%
  • Real growth of 2% to 3%
  • That gives nominal growth of 5.0% to 6.0%.

Growth

Nominal GDP growth ticked up to 6.3% for the 12 months to September, but the long-term trend is downward.

Nominal GDP Growth

Growth in Aggregate weekly hours worked declined to 1.1% for the 12 months to October — a good indicator of real growth.

Estimated Aggregate Non-Farm Weekly Hours Worked

Continued unemployment claims are climbing, suggesting that (real) growth will slow further in the months ahead.

Continued Claims

Inflation

The other component of nominal GDP growth is inflation, where five-year consumer expectations (from the University of Michigan survey) have climbed to above 3.0%.

University of Michigan Inflation Expectations 5-Year

However, core PCE inflation (orange) and trimmed mean PCE (red) are both trending lower.

Core PCE & Trimmed Mean PCE Inflation

Services PCE inflation (brown below) is also trending lower but likely to prove more difficult to subdue.

PCE Services Inflation

Real Interest Rate

Jim Bianco suggests that nominal GDP growth will fall to between 5.0% and 6.0% in 2024 — a good approximate of return on new investment  — while the 10-year yield will rise to a similar level. This represents a neutral rate of interest  that is unlikely to fuel further inflation.

10-Year Treasury Yield & Nominal GDP Growth

Inflation builds when the 10-year yield exceeds GDP growth by a wide margin. The long-term chart below shows how PCE inflation (red) climbs when 10-year Treasury yields minus GDP growth (purple) fall near -5.0%. Inflation also falls sharply when the purple line rises above 5.0%, normally during a recession when GDP growth is negative.

10-Year Treasury Yield minus Nominal GDP Growth & PCE Inflation

Conclusion

Jim Bianco’s premise of 10-year yields at 5.5% is based on the expectation that the Fed will maintain neutral real interest rates in order to tame inflation. Whether the Fed will be able to achieve this is questionable.

Japan and China have stopped investing in Treasuries, commercial banks are net sellers, and the private sector does not have the capacity to absorb growing Treasury issuance to fund federal deficits. That leaves the Fed as buyer of last resort.

The Fed may be forced to intervene in the Treasury market, keeping a lid on long-term yields while expanding the money supply. The likely result will be higher inflation and a weaker Dollar, both of which are bullish for Gold.

Acknowledgements

  • CNBC/Jim Bianco: 10-Year Treasury yield to rebound to 5.5%
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Australia: Monthly CPI proving “sticky”

Australian monthly CPI fell to 4.9% for the 12 months to October while trimmed mean — the RBA’s favorite measure of underlying inflation — edged down slightly, from 5.4% in September to 5.3% in October. This supports the RBA governor’s message that services inflation may prove difficult to tame.

Australian CPI, Core CPI, and Trimmed Mean

Especially when one considers that electricity prices are measured net of government rebates and relief payments. Before adjustment, electricity prices increased by 14.0% over the past 12 months and not the 10.1% included in CPI.

Australian CPI: Electricity Prices

Monthly rent inflation also shows a surprising fall from 7.6% for the 12 months to September — to 6.6% in October. The decline of 1.0% was again due to adjustment for Commonwealth Rent Assistance payments.

Australian CPI: Dwellings & Rent

In monthly terms, Rent prices fell 0.4% in October, following a 0.3% rise in September. The fall in Rents this month was due to the remaining impact of the changes to Commonwealth Rent Assistance. From 20 September the maximum rate available for rent assistance increased by 15%, on top of the regular biannual indexation. An increase in rent assistance reduces rents for eligible tenants. Excluding the changes to rent assistance, Rents would have risen 0.7% over the month. (ABS)

Conclusion

CPI inflation is understated by adjustment for Government rebates and assistance payments. Trimmed mean CPI is proving “sticky” and may require further rate hikes from the RBA.

Acknowledgements

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S&P 500 rallies while consumer sentiment falls

The University of Michigan Index of Consumer Sentiment declined to 61.3 for November. Levels below 70 in the past have signaled a recession.

University of Michigan Consumer Sentiment

Consumer sentiment is in sharp contrast to robust personal consumption expenditures which at 93% of disposable personal income are well above pre-pandemic levels.

Personal Consumption Expenditure/Disposable Personal Income

Mortgage rates above 7.0% failed to dampen discretionary spending, with most households having locked in low fixed mortgage rates over the pandemic.

30-Year Mortgage Rate

Home Sales

Existing home sales declined to an annual rate of 3.8 million, with households are reluctant to give up their cheap fixed-rate mortgages.

Existing Home Sales

New home sales surged as a result, boosting residential construction.

New One-Unit Home Sales

Inflation Expectations

The University of Michigan November survey shows 1-year inflation expectations increased to 4.50%.

University of Michigan Inflation Expectations 1-Year

Five-year expectations increased to 3.2%, with the 3-month moving average of 3.0% well above the Fed’s 2.0% target.

University of Michigan Inflation Expectations 5-Year

Rising inflation expectations mean that the Fed is unlikely to cut interest rates in the foreseeable future.

Interest Rates

10-Year Treasury yields continue to test support at 4.40% after Treasury weighted new issuance towards the front-end of the yield curve — largely funded by money market funds currently invested in repo. Breach of support would offer a target of 4.0% — bearish for the Dollar.

10-Year Treasury Yield

Stocks

The S&P 500 is testing its July high of 4600. Breakout is uncertain but would not signal a bull market unless confirmed by other indices.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) has recovered less than 60% of its last decline.

S&P 500 Equal-Weighted Index

The Russell 2000 Small Caps ETF (IWM) is even weaker, retracing less than 50% of its last decline, suggesting that investors have little appetite for risk.

Russell 2000 Small Caps Index iShares ETF (IWM)

Dow Jones Transportation Average has also retraced less than 50%. The Trend Index below zero continues to warn of selling pressure.

Dow Jones Transportation Average ($DJT)

Gold and the Dollar

The Dollar Index retraced to test resistance at 104. Respect is likely and breakout below 103 would offer a target of 100.

Dollar Index

The weakening Dollar is bullish for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of the previous high at $2050.

Spot Gold

Commodities

Dow Jones Industrial Metals Index ($BIM) fell sharply, warning of another test of primary support at 153. Breach would warn of a global recession, especially if mirrored by a similar breach in Copper.

Dow Jones Industrial Metals Index ($BIM)

Copper is testing its descending trendline at 8300. Reversal below primary support at 7800 would warn of a global recession. China consumes about 50% of the world’s copper production, most of it used in construction. So a lot depends on China’s efforts to rescue their ailing property sector.

Copper

The downward spiral of China’s ailing property sector shows no sign of abating despite the government’s rollout of a seemingly endless series of supportive but as yet ineffective measures, with the crisis stretching for over three years…..

The market for Chinese developers’ dollar-denominated bonds has seen a meltdown over the past two years, losing 87% of its value. The rout has wiped out $135.5 billion of value from $154.9 billion of outstanding notes, according to analysis by Debtwire. (Caixin)

Brent crude is testing resistance at $83 per barrel. Respect would warn of another downward leg to $72 and strengthen a bear market warning from Copper and base metals.

Brent Crude

Conclusion

Personal consumption expenditures remain strong despite falling consumer sentiment. The S&P 500 is testing resistance at 4600 but the advance is narrow, with investors avoiding risk in the broader market.

The Dollar weakened on the back of falling long-term Treasury yields, boosting demand for Gold which is testing resistance at $2000 per ounce. Breakout would offer a short-term target of $2050.

Copper and base metals are expected to again test primary support as doubts remain over China’s ailing property sector. Breach of support would warn of a global recession.

Inflation expectations remain persistent, with five-year expectations at 3.0% in the November University of Michigan consumer survey, well above the Fed’s target of 2.0%. The likelihood of rate cuts in early 2024 is remote unless a major collapse in financial markets forces the Fed’s hand.

Acknowledgements

Macrobusiness: China’s property black hole sucks in the CCP.

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Moody’s negative outlook and falling consumer sentiment

Ten-year Treasury yields continue to respect support at 4.50%. We expect another test of resistance at 5.0%.

10-Year Treasury Yield

Moody’s kept their AAA rating for the US government but changed their outlook from stable to negative. The reasons cited  — large deficits and a polarized ineffective Congress — are strong arguments for higher Treasury yields:

Moody's Rating

Japan has also broken above 150 yen to the Dollar, increasing pressure on the BoJ to relax their cap on long-term JGB yields. Any move to relax yield curve control would be likely to cause an outflow from US Treasuries and the Dollar, driving down prices.

USDJPY

Inflation

Inflation expectations are rising, with University of Michigan 1-year expectations jumping to 4.4% — and the 3-month moving average to 3.9%.

University of Michigan Inflation expectations 1-Year

Five-year expectations are also rising, reaching 3.2% in October, with the 3-month moving average at 3.0%.

University of Michigan Inflation expectations 5-Year

Higher inflation expectations add to upward pressure on long-term yields.

Financial Conditions

Financial conditions remain loose — despite the strong rise in long-term yields — with the spread between Baa corporate bonds and the equivalent Treasury yield at a low 1.84%.
Moody's Baa Corporate Bond Spreads

Economic Outlook

Low consumer sentiment, with the University of Michigan Index at 64, continues to warn of a recession.
University of Michigan Consumer Sentiment

Heavy truck sales — a reliable leading indicator — are falling steeply. A fall below 35,000 units would be cause for concern.

Heavy Truck Sales

Stocks

The S&P 500 ended the week stronger, with a bullish candle testing resistance at 4400.

S&P 500

Small caps continue to warn of weakness, however, with the Russell 2000 iShares ETF (IWM) likely to test primary support at 162. Trend Index peaks below zero warn of strong selling pressure. Small caps tend to outperform large caps by a wide margin in the first phase of a bull market — clearly not the case here.

Russell 2000 Small Caps iShares ETF (IWM)

Global Economy

Copper is retracing for another test of primary support at $7800 per metric ton. Breach would warn of a global recession.

Copper

Gold

Gold broke support at $1900 per ounce, indicating a test of $1900. Rising long-term interest rates are undermining investor demand for Gold.

Spot Gold

But Gold is supported by strong central bank purchases, led by China.

Central Bank Gold Purchases & Sales

Australia

The ASX 200 retreated below 7000 on Friday but a bullish close on the S&P 500 should see retracement to test resistance. Declining Trend index peaks, however, warn of rising selling pressure.

ASX 200

Conclusion

We expect upward pressure on long-term Treasury yields to continue, boosted by Moody’s negative outlook for the US, a weakening Japanese Yen and rising inflation expectations.

Declining heavy truck sales and weak consumer sentiment are bearish for the economy. The S&P 500 remains bullish but small caps are more bearish, warning that this is not a broad-based recovery.

Copper breach of $7800 per metric ton would warn of a global recession.

We remain overweight cash, money market funds, short-duration term deposits and financial securities (up to 12 months), defensive stocks, critical materials and gold.

Acknowledgements

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Debt reduction, buybacks and S&P 500 P/E multiples

There is a rising trend — especially in the telecommunications, utilities, and REITs sectors — of selling off non-core assets and using the proceeds to reduce debt. Rising long-term interest rates are likely to accelerate this trend.

Debt reduction reduces funds available for stock buybacks. This chart from S&P Dow Jones Indices shows buybacks on the S&P 500 have been declining since Q2 of last year.

S&P 500 Buybacks

Without buybacks, S&P 500 earnings growth is expected to follow declining year-on-year sales growth, removing the justification for high earnings multiples.

S&P 500 Sales Growth

Price-earnings multiple for the S&P 500 is expected to decline towards its 50-year average of 16.4.

S&P 500 Price/Highest Trailing Earnings

Conclusion

Debt reduction is likely to accelerate the decline of stock buybacks, eroding support for elevated price-earnings multiples.

Declining sales growth is likely to reduce earnings growth and further erode the justification for high earnings multiples.

The price-earnings multiple for the S&P 500 is expected to decline towards its 50-year average of 16.4 (based on highest trailing earnings).

Acknowledgements

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Stan Druckenmiller’s macro outlook

“….We need to make an adjustment fundamentally and price wise. And if you look at the market, in the non-QE world, free world, 15 times earnings was about right. We’re at 20 times earnings. I don’t know what we’re doing 20 times earnings. It’s hard for me to get excited about the long side of the overall market with the market, say, 20% above its normal valuation. When you have a federal fiscal recklessness problem, you have supply chain problems, you have the worst geopolitical situation I’ve seen in my lifetime.

’78, ’79 was bad. But I mean, for the first time, it’s a very low probability, but you gotta put the potential outcome of World War on the table. Not exactly an environment that excites me about paying 20 to 30%, above the multiple for equity prices. The next six months, who knows? And we’re certainly washed out to some extent.”

Acknowledgements

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