In Asia, South Korea’s Seoul Composite Index found support at 2450 but be careful of a bearish divergence forming on Twiggs Trend Index. Reversal below zero would warn of a test of primary support at 2300.
Japan’s Nikkei 225 Index remains bullish. Trend Index troughs high above zero indicate strong buying pressure.
China’s Shanghai Composite Index found support at 3250. Breakout above 3450 would signal a primary advance.
India’s NSE Nifty Index broke resistance at 10500, signaling a fresh advance. Trend Index troughs above zero signal buying pressure. The immediate target is 11000*.
Target 10500 + ( 10500 – 10000 ) = 11000
In Europe, the Footsie is advancing strongly after breaking through resistance at its June high of 7600. Trend Index is still declining but recovery above the declining trendline indicates buyers are taking control.
Europe, represented by the DJ Euro Stoxx 600, remains weak. A declining Trend Index warns of selling pressure despite breakout above resistance at 396.
Moving to the US, the S&P 500 chart says it all. Investors continue to shrug off concerns about high valuations. The rising Trend Index, high above zero, indicates strong buying pressure. We need a correction fairly soon to prevent an accelerating up-trend leading to a blow-off.
Commodities are also advancing, led by stronger crude oil prices.
It’s about time that the Fed and other central banks took the punch bowl away, before the party really gets out of hand.
Gold rallied strongly on the back of a weak Dollar. A rising Trend Index indicates buying pressure. Breakout above $1350 is likely and would signal a fresh advance.
The Dollar is weakening which is bullish for gold. Follow-through of the Dollar Index below 91 would signal a primary decline with a target of 87*. Trend Index peaks below zero warn of strong selling pressure.
The ASX 200 retraced to test its new support level at 6050. Falling 21-day Twiggs Money Flow indicates medium-term selling pressure. Breach of 6050 would warn of a test of 5900.
The current advance is fueled by rising commodity prices, with the ASX 300 Metals & Mining index advancing strongly.
But the ASX 300 Banks index is pulling in the opposite direction, respecting resistance at 6500 while the Trend Index continues to warn of moderate selling pressure. Breach of 8300 is likely and would warn of a test of primary support at 8000/8100.
Target for the ASX 200 is the 2007 high of 6800 but a lot will depend on the relative strength of banks v. miners.
The Footsie is testing resistance at its June high of 7600. Trend Index is still declining but recovery above 0.2% would indicate buyers are taking control.
Europe is weaker, with tall shadows on weekly Dow Jones Euro Stoxx 600 candles and a declining Trend Index warning of selling pressure.
In Asia, South Korea’s Seoul Composite Index broke support at 2450, confirming the bearish divergence on Twiggs Trend Index. Expect a correction to test primary support at 2300.
Japan’s Nikkei 225 Index remains bullish, consolidating in a narrow band below resistance at 23000. Trend Index troughs high above zero indicate strong buying pressure.
China’s Shanghai Composite Index found short-term support at 3250. Bearish divergence on the Trend Index warns of selling pressure.
India’s NSE Nifty Index is testing resistance at 10500 after a mild correction to 10,000. Twiggs Trend Index respecting zero signals strong buying pressure. Breakout above 10500 is likely and would indicate another primary advance with an immediate target of 11000*.
Target 10500 + ( 10500 – 10000 ) = 11000
Moving to the US, the S&P 500 continues to shrug off concerns over high valuations and a flattening yield curve. The rising Trend Index, high above zero, indicates long-term buying pressure.
Bellwether transport stock Fedex has advanced to 250, signaling strong economic activity, a bullish sign for the entire economy.
The ASX 200 broke through 6050 after respecting support at 5900 over the last few weeks. Expect retracement to test the new support level. Bearish divergence on Twiggs Money Flow remains a concern, warning of large numbers of sellers. Target for the primary advance is the 2007 high of 6800 but I remain wary because of selling pressure and banking sector weakness.
The ASX 300 Banks index found short-term support at 8300. Twiggs Trend Index continue to warn of moderate selling pressure. Breach of 8300 is likely and would warn of a test of primary support at 8000/8100.
Gold bounced off support at $1240/ounce, ending the week with a strong rally. Penetration of the descending trendline would indicate the down-trend has weakened, while breakout above $1300 would suggest another advance. Twiggs Trend Index close to zero still indicates hesitancy.
The greenback is weakening which is bullish for gold. Dollar Index reversal below 93 (and the rising trendline) would indicate another test of primary support at 91. A major Trend Index peak below zero would warn of another primary decline with a target of 87*.
* Target calculation: 91 – (95 – 91) =87
Australia’s All Ords Gold Index is headed for another test of long-term resistance at 5000. Breakout would signal a primary advance.
A weakening Aussie Dollar would strengthen demand for gold stocks. Respect of resistance at 77.5 US cents by the current bear rally would warn of a decline to test primary support at 73.5.
Starting with Asia, South Korea’s Seoul Composite Index continues to test support at 2450. Bearish divergence on the Trend Index warns of selling pressure but this appears secondary in nature. Breach of the rising trendline would warn that the primary up-trend is losing momentum.
Japan’s Nikkei 225 Index is consolidating between 22000 and 23000. A Trend Index trough high above zero indicates strong buying pressure.
China’s Shanghai Composite Index is undergoing a correction that should find support at 3200. Bearish divergence on the Trend Index, and a cross below zero for the first time since May 2016, warn of continued selling pressure.
India’s NSE Nifty Index continues to test support at 10000 after a weak correction. Twiggs Trend Index respecting zero signals strong buying pressure. Recovery above 10500 is likely and would indicate another primary advance.
Target 10500 + ( 10500 – 10000 ) = 11000
Europe is weaker despite strong manufacturing signals. Dow Jones Euro Stoxx 50 found support at 3520 but the Trend Index is declining, warning of selling pressure. Breach of 3520 is likely and would warn of a test of primary support at 3400.
The Footsie remains volatile, with the index headed for another test of stubborn resistance at 7600. But Trend Index is declining and continues to warn of selling pressure.
Moving to the US, the S&P 500 continues to shrug off concerns regarding high valuations and a flattening yield curve. The rising Trend Index, high above zero, indicates long-term buying pressure.
The Nasdaq 100 also continues a strong bull market, with the big five tech stocks (Apple, Amazon, Alphabet, Microsoft and Facebook) all recording solid gains.
Bulls were baited with a third ASX 200 breakout above resistance at 6000, only to see the index retreat yet again. Declining Money Flow warns of commitment from sellers. Breach of support at 5920 would confirm a correction already signaled by Money Flow (21-day) crossing to below zero.
The ASX 300 Retailing Index is weak, anticipating a poor Christmas.
But Food & Staples Retailing is strengthening.
ASX 200 direction, however, is largely determined by Banks and Miners.
The bear-trend on iron ore is weak, with the bulk commodity continuing its test of resistance at 70. Respect would warn of another decline, while breakout above 80 would signal a primary up-trend.
The ASX 300 Metals & Mining Index, however, shows signs of selling pressure, with Money Flow (21-day) declining to zero. Breach of support at 3300 would warn of a correction.
Banks continue to disappoint, with the ASX 300 Banks index headed for a test of short-term support at 8250. Twiggs Trend Index peaks below zero indicate continued selling pressure. Breach of 8250 is likely and would warn of a test of primary support between 8000 and 8100.
The greenback continues its bear market rally, assisted by the new tax bill and the December Fed rate hike. Breakout above resistance at 95 would signal a primary up-trend, a strong bear signal for gold, but the Dollar still has to overcome concerns over North Korea.
Gold found short-term support at $1240/ounce and recovery above the descending trendline would indicate that the down-trend is weakening. Breach of primary support at $1200 is unlikely but would be a strong bear signal, warn of a primary down-trend.
The All Ords Gold Index is also correcting. Breach of primary support at 4300 would warn of a primary down-trend.
But I expect this to be cushioned by further weakness on the Aussie Dollar.
Helped in part by a declining yield differential between Australian and US government bonds.
GDP growth has lifted in 2017 and the labour market has tightened.
Our base case has these trends continuing over the next two years, but there are a number of downside risks.
The ability of monetary policy to support the economy in the event of a negative shock is more limited than in the past thereby exacerbating the potential impact that any negative shock may bring.
On some important metrics it’s been a reasonably good for year the Australian economy. The labour market has tightened courtesy of very strong employment growth and real GDP growth has lifted. At the same time, nominal GDP growth has been buoyant due to firmer commodity prices when compared to a year earlier. Wages growth, however, remains soft and real wages are barely in positive territory.
The house view is that the improvement in the labour market continues over the next two years and the unemployment rate should continue to grind lower. But there are plenty of risks that would change the outlook if they were to materialise.
This note discusses some of the key global and domestic risks to the Australian economy. It begins with an outline of CBA’s base case for the economy over the next two years before delving into some of the potential risks. This is not an exhaustive list, but rather it covers a few areas that the author considers to be the most acute risks to our central scenario. They are: (i) the capacity to respond to a negative shock with monetary policy (and to a lessor extent fiscal policy), (ii) a solid fall in commodity prices; (iii) a sharp correction in dwelling prices; (iv) a policy “mistake”; and (v) a fall in net migration via a policy change.
CBA’s central scenario
CBA’s base case for the economy over the next two years is a benign one. It is broadly similar to the RBA’s forecast profile for the economy which is also not dissimilar to the consensus view.
On the key components, we see output growth continuing to lift to a pace of around 3%pa in 2018 (chart 1). We put potential growth at 2¾% (population plus productivity growth) which means our forecast profile has a gradual decline in the unemployment rate as spare capacity recedes (chart 2). In 2018, most of the key components of the economy are expected to contribute to growth, with dwelling investment the exception.
The capacity of wages growth to slow further from here is also limited in the event of a commodity price shock. That is because wages growth is already at record lows and wages growth is sticky downwards. A fall in wages growth was able to cushion the most recent terms-of-trade shock (late-2011 to early 2016) because growth in wages slowed in line with the weakness in commodity prices. This helped to support the labour market and keep the unemployment rate from rising as much as it otherwise might have. But this time, a fall in wages growth will not be able to absorb the shock to the same extent given wages growth is already so low.
A sharp correction in dwelling prices
The single biggest risk to the domestic outlook looks to be a sharp correction in dwelling prices. In our view, this carries a greater risk to the real economy than it does to financial stability given the banking system is well capitalised.
There is a commonly held belief in Australia that the main trigger for a fall in dwelling prices is a rise in unemployment. This seems logical because rising unemployment would generally be associated with a lift in mortgage delinquencies which would put downward pressure on prices. But the data suggests that employment is more likely to lag changes in dwelling prices rather than lead (chart 12). The obvious question to then ask is why? We attribute the answer, in part, to the wealth effect and the recent track record of monetary policy in smoothing out the business cycle.
In periods when employment growth is slowing, the RBA is generally easing policy. When this is occurring, as long as the RBA can fend off a recession, falling interest rates tend to push up dwelling prices via cheaper credit which in turn encourages spending and supports employment growth. Of course, it’s a different story if employment growth falls too fast and unemployment rises sharply. But so far, at the national level, this hasn’t happened since the recession of the early 90s.
The risk of a material correction in dwelling prices looks higher now than it has been for a long time given: (i) the incredible lift in dwelling prices over the past five years; (ii) mortgage rates are probably unlikely to go lower and indeed can’t go much lower; (iii) household debt to income is at a record high; and (iv) dwelling supply is in the process of lifting quite significantly in some jurisdictions.
A soft correction in dwelling prices would probably have no material negative impact on the labour market. But there is a risk that a hard correction in prices (a fall of 20% or more) would lead the economy into a downturn via the wealth effect (i.e. the notion that changes in demand are influenced by changes in the value of assets). Since income to one person comes via the spending of another, there is a risk that falling home prices leads households to put the brakes on spending which ultimately drags consumption and employment growth lower.
A policy “mistake”
We consider a policy mistake by the central bank to be a risk to the economy given how much debt the household sector is carrying. Specifically, if the RBA hikes too early it could derail the improvement in the labour market that has been underway over the past two years. The record level of debt being carried by the household sector means that interest payments as a share of income will rise quickly if/when rates move higher (chart 13).
The construction sector in Australia, for example, is proportionately bigger than the construction sector in most other advanced economies because strong growth in people means that more needs to be built – dwellings, roads, schools, hospitals, ports etc. Finally, at the margin, a strong population growth rate at a time when there is labour market slack is likely to be putting downward pressure on wages as workers from offshore add competition to domestic labour.
At present, both major sides of politics (i.e. the Liberal-National Coalition and the Labor party) support maintaining a high permanent migrant intake every year. But there is a risk that one of the major parties opts for a different policy stance. The example here is to be found in New Zealand where there has been a change in immigration policy following the recent election outcome that means migration should drop substantially over the next few years. As a result, a change in immigration policy cannot and should not be ruled out in Australia.
A material reduction in net migration to Australia would increase the risk of a fall in dwelling prices as well as weigh on total output growth (not GDP per capita) and negatively impact the construction sector. But it would also likely put upward pressure on wages growth by reducing the pool of workers in many occupations. In that context, it’s not so much a downside risk, but rather one that would see a shift in the economic outlook that would have both winners and losers. From a policy perspective it’s about assessing whether there is a net societal benefit. But that’s a question for another day.
Dow Jones Euro Stoxx 600 found support at 380 and is now headed for a test of recent highs at 395. Bearish divergence on the Trend Index continues to warn of selling pressure but recovery above the declining trendline (on the Trend Index) would indicate that pressure has eased. Breakout above 395 would signal another primary advance, with a target of 425*.
Target 395 + ( 395 – 365 ) = 425
Conclusion of phase I of Brexit negotiations helped the Footsie find support at 7300. Trend Index continues to warn of selling pressure. Breach of 7200 is unlikely at present but would signal a primary down-trend. Breakout above 7600 would signal a primary advance, but is also unlikely. Expect further consolidation.
In Asia, South Korea’s Seoul Composite Index is undergoing a correction but seems to have found support at 2450. Respect of the rising trendline would confirm the primary up-trend.
Japan’s Nikkei 225 Index found solid support at 22000, with long tails signaling buyer enthusiasm. The trend index trough high above zero indicates strong buying pressure.
China’s Shanghai Composite Index is undergoing a correction. A long tail suggests support at 3250. Bearish divergence on the Trend Index warns of selling pressure but this appears to be secondary in nature.
India’s NSE Nifty Index found support at 10000 after a weak correction. Recovery above 10500 is likely and would warn of another primary advance.
Target 10500 + ( 10500 – 10000 ) = 11000
In the US, the S&P 500 continues to shrug off concerns regarding high valuations and a flattening yield curve. The rising Trend Index indicates buying pressure.
The Nasdaq 100 continues its strong bull market, powered by the big five tech stocks (Apple, Amazon, Alphabet, Microsoft and Facebook). Corrections are mild and of short duration, typical of the latter stages of a bull market.
The ASX 200 index is running up against resistance at 6000. Reversal below support at 5920 would signal a correction. As would Twiggs Money Flow (21-day) crossing to below zero.
Iron ore is testing resistance at 70. Respect would warn of another (primary) decline. Breakout above 80 would signal a primary up-trend but that is unlikely if China continues to crack down on bank lending.
The ASX 300 Metals & Mining Index is testing support at 3300. Decline of the Trend Index below zero warns of medium-term selling pressure. Breach of 3300 would warn of a correction.
The ASX 300 Banks index found short-term support at 8300. Recovery above 8500 would be a bullish sign but respect is more likely and would warn of a test of primary support between 8000 and 8100.
Gold broke support at $1250/ounce, warning of a test of primary support at $1200. Breach of primary support at $1260 remains unlikely but would warn of long-term down-trend.
The greenback rallied on passing of the new tax bill. A test of resistance at 95 is now likely. Breakout above 95 would signal a primary up-trend, bearish for gold.
Long-term Treasury yields are gradually strengthening, with the 10-year expected to test resistance at 2.50%. Breakout above 2.5/2.6 would signal a primary up-trend which again would be bearish for gold.
A long-term chart of gold shows the precious metal retains its bullish bias. There is strong resistance at $1350 opposed by a broad band of support between $1050 and $1200. Respect of $1200 would signal another test of resistance, while breach of $1150 would warn of a primary down-trend.
The All Ords Gold Index is also correcting but is somewhat cushioned by the falling Australian Dollar, now at 75 US cents. Respect of the rising trendline would be bullish, while breach of primary support at 4300 would warn of a down-trend.
Crude is running into resistance at $60/barrel after a strong advance over the last three months. Two retracements in quick succession suggest that the commodity is running into resistance as it approaches its 2015 high.