Around the markets: Hong Kong & India bullish

Canada’s TSX 60 continues to test resistance at the former primary support level of 900. Bearish divergence on Twiggs Money Flow warns of strong selling pressure. Decline below 880 would confirm a primary down-trend, with an initial target of 865*.

TSX 60 Index

* Target calculation: 900 – ( 935 – 900 ) = 865

The Footsie recovered above 7400 but bearish divergence on Twiggs Money Flow warns of long-term selling pressure. Another test of primary support at 7100 remains likely.

FTSE 100 Index

European stocks are taking a beating, with the Dow Jones Euro Stoxx 50 Index testing support at 3400. Sharp decline on Twiggs Money Flow warns of selling pressure. Breach of 3400 would warn of a test of 3200.

DJ Euro Stoxx 50 Index

* Target calculation: 3650 – ( 3650 – 3450 ) = 3850

India’s Sensex remains in a bull market.

BSE Sensex

* Target calculation: 29000 + ( 29000 – 26000 ) = 32000

As does Hong Kong’s Hang Seng Index.

Hang Seng Index

* Target calculation: 24000 – ( 24000 – 21500 ) = 26500

While China’s Shanghai Composite index ranges between 3000 and 3300. Government interference remains a concern.

Shanghai Composite Index

ASX 200: It’s down to iron ore

Iron ore encountered resistance at $70 per ton. Another test of primary support at $53 is likely. But a failed down-swing would be a bullish sign.

Iron Ore

The ASX 300 Metals & Mining displays a similar pattern, retreating below 3000 after testing 3050. A failed down-swing that ends above 2750 would be a bullish sign, while breach of support at 2750 would confirm the primary down-trend.

ASX 300 Metals & Mining

APRA eased pressure on the big four banks to raise more capital; the ASX 300 Banks index responding with a rally to 8800. Retracement that respects support at 8500 would be a bullish sign, signaling continuation of the up-trend. The industry is still light on capital but recent remarks by APRA chair Wayne Byres indicate that they are prepared to tolerate a more gradual adjustment rather than a new round of capital raising. Dividends may still come under pressure, however, in banks with high payout ratios.

ASX 300 Banks

ASX 200 consolidation between 5600 and 5800 continues. Declining Twiggs Money Flow flags selling pressure. Breakout from the consolidation will indicate future direction but this is likely to be dominated by mining (iron ore) and the banks. If both are pulling in the same direction, the index is likely to follow. Banks are increasingly bullish but the question-mark over iron ore remains.

ASX 200

Gold rallies as Dollar plunges

The Dollar Index is in a primary down-trend. Its decline accelerated in the last week, headed for the next level of primary support between 92 and 93, which is bullish for gold.

Dollar Index

Falling crude prices, however, have a bearish influence on gold. Nymex light crude recently staged a rally but ran into resistance at $47.50/barrel. Expect another decline to test the lower trend channel at $42, continuing the primary down-trend.

Nymex Light Crude

Gold broke resistance at $1250/ounce. Follow-through above $1260 would signal another test of resistance at $1300. Reversal below $1250, on the other hand, would be a bearish sign.

Spot Gold

Silver rallied off primary support at $15.50/ounce but only a break above the descending trendline (at $17/ounce) would flag a reversal in the primary down-trend.

Spot Silver

Australia: Job gains

ABS June figures reflect solid gains for the labor market. Justin Smirk at Westpac writes:

“….The annual pace of employment growth has lifted from 0.9%yr in February to 2.0%yr in May and it held that pace in June. In the year to Feb there was a 106.9k gain in employment; in the year to June this has lifted to 240.2k. The Australian labour market went through a soft patch in 2016 that was particularly pronounced through August to November when the average gain in employment per month was a paltry 2.2k. We have clearly bounced out of this soft patch and now holding a firmer trend.”

My favorite measure, monthly hours worked, jumped (year-on-year) by 3.1%.

Monthly Hours Worked

Infrastructure spending, particularly in NSW and Victoria, is doing its best to offset weakness in other areas.

Wage rate growth remains subdued, indicating little pressure on the RBA to lift rates.

Monthly Hours Worked

VIX hits record low

The CBOE Volatility Index (VIX) made a new low of 9.30 indicating record low levels of stock volatility. High levels of stock buybacks and large ETF fund inflows may both have contributed, but this is only the third time in its 27-year history that index has broken below 10%. The first was in late 1993. The second, in late 2006, was followed a year later by a massive market snap-back. This time is no different. Volatility is unlikely to remain at such low levels and eventually we will see a market down-turn, accompanied by high volatility, but there is no crystal ball that can tell us whether this will be in one year or five.

CBOE Volatility Index (VIX)

Corporate bond spreads are also falling, with the spread between lowest investment grade Baa (10-year) and equivalent Treasury yields at their lowest point since 2008.

Corporate Bond Spreads

Source: St Louis Fed & Moody’s

The yield curve is flattening but remains comfortably above a flat or negative yield curve when
the yield differential (10-year minus 3-month yields) falls below zero. A negative yield curve is a reliable warning of recession within 12 months.

Yield Differential

Source: St Louis Fed

The Freight Transportation Services Index displays a steady increase in economic activity.

Freight Transportation Services Index

Source: St Louis Fed & US Bureau of the Census

And the S&P 500 continues its advance towards 2500.

S&P 500

Target 2400 + ( 2400 – 2300 )

Weekly Top Themes from Bob Doll | Nuveen

  1. U.S. monetary policy should remain equity-market friendly. In her comments last week, Janet Yellen stated that the neutral rate for the fed funds rate is “currently quite low,” and rates would not have to rise much more to become neutral. In our view, a neutral fed funds rate is closer to 2% than the 3% currently implied by the fed funds futures market. If this is accurate, it would likely be good news for economic growth, corporate earnings and the stock market.
  2. Global monetary policy is starting to normalize, but still supports stocks. The Bank of China raised rates by 25 basis points last week and other central banks are becoming less dovish. We think this is good news since it reflects improving global economic growth, while overall policy remains easy. Central banks are still promoting liquidity, which should support equities and other risk assets.
  3. Inflation remains surprisingly low. Although economic growth is improving and the Fed is normalizing, inflation has not increased similarly. Inflation should eventually react to tightening labor markets, but the process is taking a long time.
  4. If the “Goldilocks” environment persists, we think equities can continue to make all-time highs. Low inflation, slow-but-positive economic growth, climbing earnings and a cautious Fed have contributed to record-high stock prices. We think these conditions should remain in place for at least the next 6 to 12 months.
  5. Active fund manager performance has improved. According to Merrill Lynch, 54% of active large cap U.S. equity managers outperformed their benchmarks for the first half of the year and more than half also outperformed for the last four months. This is the longest such streak since Merrill Lynch began tracking this data in 2009, and it marks the first time a majority of managers outperformed for the first half of a year.

Global monetary policy supportive of stocks, low inflation and slow-but-stable earnings growth. Nothing much wrong here. Inflation is the one to watch though. A surge in wage rates as the labor market tightens would tighten monetary policy, with a domino effect on earnings and stock performance.

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Icarus trade continues, with the next global crisis further away than you think

Good to see Ambrose Evans-Pritchard weighing in on the (absence of) the next global financial crisis:

….If corporation tax drops to 25 per cent and incentives are offered to repatriate up to $US4 trillion of US corporate cash held offshore – tinder for stock buy-backs – you might see the sharemarket’s price earnings ratio breaking the all-time high of the dotcom boom.

Whether any of this stimulus is wise is another matter. The Bank for International Settlements chides central banks for making a Faustian Pact long ago, rescuing markets every time there is trouble but letting asset bubbles run unchecked in the good times.

They have created “intertemporal” imbalances that require ever lower real interest rates with each cycle. The deformity is worse today than before the Lehman crisis after eight years of emergency stimulus.

The global debt ratio is 40 percentage points higher at 327 per cent of GDP. Nobody knows what the sensitivity may be to even a modest degree of tightening.

Yet if the Sword of Damocles hangs ever over us, that does not mean it is about to fall. My humbling discovery after decades of amateur observation is that such episodes take longer to play out than you imagine.

I was convinced that the global financial system was spiralling into crisis at least 18 months before Fannie Mae, Freddie Mac, and Lehman Brothers collapsed over those terrifying weeks of late 2008.

That was a bad call. Even disasters have their proper sequencing.

Source: Icarus trade continues, with the next global crisis further away than you think

Australia: APRA capitulates to Big Four banks

From Clancy Yeates at The Age:

Quelling investor fears over moves to strengthen the financial system, the Australian Prudential Regulation Authority on Wednesday said major banks would have until 2020 to increase their levels of top-tier capital by about 1 percentage point, to 10.5 per cent.

The target was much more favourable to banks than some analyst predictions, with some bank watchers in recent months warning lenders may need to raise large amounts of equity or cut dividends to satisfy APRA’s long-running push for “unquestionably strong” banks.

Markets are now confident banks will hit APRA’s target, estimated to require about $8 billion in extra capital from the big four, through retained earnings or by selling new shares through their dividend reinvestment plans…..

“The scenario where banks had to raise significant capital appears to be off the table for now,” said managing partner at Arnhem Asset Management, Mark Nathan.

Mr Nathan said the banks’ highly prized dividends also looked “safer”, though were not likely to increase. National Australia Bank and Westpac in particular have high dividend payout ratios, which could put dividends at risk from other factors, such as a rise in bad debts……

APRA’s chair Wayne Byres said the changes could be achieved in an “orderly” way, and the new target would lower the need for any future taxpayer support for banks.

“APRA’s objective in establishing unquestionably strong capital requirements is to establish a banking system that can readily withstand periods of adversity without jeopardising its core function of financial intermediation for the Australian community,” he said.

APRA chairman Wayne Byres used the words “lower the need for any future taxpayer support.” Not “remove the need…..” That means banks are not “unquestionably strong” and taxpayers are still on the hook.

A capital ratio of 10.5% sounds reasonable but the devil is in the detail. Tier 1 Capital includes convertible (hybrid) debt and risk-weighted assets are a poor reflection of total credit exposure, including only that portion of assets that banks consider to be at risk.

Recent bailout experiences in Europe revealed regulators reluctant to convert hybrid capital, included in Tier 1, because of fears of panicking financial markets.

Take Commonwealth Bank (Capital Adequacy and Risks Disclosures as at 31 March 2017) as a local example.

The Tier 1 Capital Ratio is 11.6% while Common Equity Tier 1 Capital (CET1), ignoring hybrids, is more than 17% lower at 9.6%.

But CBA risk-weighted assets of $430 billion also significantly understate total credit exposure of $1,012 billion.

The real acid-test is the leverage ratio which compares CET1 to total credit exposure. For Commonwealth this works out at just over 4.0%. How can that be described as “unquestionably strong”?

Minneapolis Fed President Neel Kashkari conducted a study last year in the US and concluded that banks need a leverage ratio of at least 15% to avoid future bailouts. Even higher if they are considered too-big-to-fail.

Round the world: India & Hong Kong advance, Canada falters

Canada’s TSX 60 retraced to test resistance at the former primary support level of 900. Respect is likely and would signal a bear market. Decline of Twiggs Money Flow/Trend Index below zero would strengthen the bear signal. Medium-term target for the decline is 865*.

TSX 60 Index

* Target calculation: 900 – ( 935 – 900 ) = 865

The Footsie is losing momentum, with penetration of successive trendlines and declining Twiggs Trend Index. A test of primary support at 7100 is likely.

FTSE 100 Index

Dow Jones Euro Stoxx 50 Index, representing the 50 largest stocks in the Euro Zone, found support above 3400. Penetration of the declining trendline would indicate the correction is over and suggest the start of another advance — confirmed if the index breaks its recent (May 2017) high.

DJ Euro Stoxx 50 Index

* Target calculation: 3650 – ( 3650 – 3450 ) = 3850

It’s full steam ahead for India’s Sensex. Trend Index troughs above zero indicate strong buying pressure. Expect some profit-taking at the target of 32000* but any correction is likely to be shallow as the bull market gathers momentum.

BSE Sensex

* Target calculation: 29000 + ( 29000 – 26000 ) = 32000

Hong Kong’s Hang Seng Index has also reached its target of 26500. Again Trend Index troughs above zero indicate solid buying pressure.

Hang Seng Index

* Target calculation: 24000 – ( 24000 – 21500 ) = 26500

China’s Shanghai Composite index is also rallying but I remain wary of government intervention.

Shanghai Composite Index

ASX buoyant as iron rallies

Iron ore broke resistance at $60 and is headed for a test of $70 per ton. This is a strong rally but it does not signal the end of the bear market. Only when the rally ends and there is another test of primary support at $53 will we be able to gauge long-term sentiment.

Iron Ore

The ASX 300 Metals & Mining index broke resistance at 3000, completing a double bottom reversal with a target of 3250. Breach of 2750 is unlikely at present but would signal a primary down-trend.

ASX 300 Metals & Mining

The ASX 300 Banks index is testing resistance at 8500 but Twiggs Money Flow below zero continues to warn of long-term selling pressure. Breach of 8000 remains likely and would confirm the primary down-trend.

ASX 300 Banks

The ASX 200 is consolidating in a small triangle (some would call this a large pennant) between 5600 and 5800. Breakout will signal future direction. A lot will depend on iron ore (China) and the banks, which seem to be pulling in opposite directions at present.

ASX 200

Gold: There’s life in the old girl yet

The Dollar Index is in a primary down-trend. Breach of support at 95.50 signals another decline. The long-term target is the 2016 low between 92 and 93.

Dollar Index

A weakening Dollar and geo-political uncertainty should fuel demand for gold, but gold and silver have both been testing support in recent weeks rather than advancing strongly as expected.

The best explanation I have for this is falling crude oil prices. The long-term chart below shows gold and crude oil prices adjusted for inflation (CPI). Whenever there is a strong surge in crude oil prices, gold tends to follow. Rising crude prices and higher consequent inflation reduce confidence in the Dollar and major oil producers tend to buy more gold with their newfound surplus, as a store of value.

Gold & Crude Oil prices adjusted for inflation

The opposite occurs if oil prices fall and those same oil producers are forced to sell gold reserves in order to fund an unexpected deficit.

At present crude prices are undergoing a bear market rally, having recovered above resistance at $45/barrel, but the primary trend is down. Gold has followed suit, recovering above support at $1215/ounce. Penetration of the declining trendline suggests a test of resistance at $1250.

Spot Gold

But crude prices remain weak and (gold) respect of $1250 would indicate another test of primary support at $1200.

US Retail & Light Vehicle Sales slow

Retail sales growth (excluding motor vehicles and parts) slowed to 2.4% over the 12 months to June 2017.

Retail Sales ex Motor Vehicles & Parts

Source: St Louis Fed & US Bureau of the Census

Seasonally adjusted light vehicle sales are also slowing.

Light Vehicle Sales

Source: St Louis Fed & BEA

Seasonally adjusted private housing starts and new building permits are starting to lose momentum.

Housing Starts & Permits

Source: St Louis Fed & US Bureau of the Census

The good news is that Manufacturer’s Durable Goods Orders (seasonally adjusted and ex Defense & Aircraft) are recovering.

Manufacturing Durable Goods Orders ex Defense & Aircraft

Source: St Louis Fed & US Bureau of the Census

Cement and concrete production continues to trend upwards.

Cement & Concrete Production

Source: US Fed

And estimated weekly hours worked (total nonfarm payroll * average weekly hours) is growing steadily.

Estimated Weekly Hours Worked

Source: St Louis Fed & BLS

All of which suggest that business confidence is growing and consumer confidence is likely to follow. Bellwether transport stock Fedex advanced to 220, signaling rising economic activity in the broader economy.

Fedex

Target: 180 + ( 180 – 120 ) = 240

The S&P 500 broke resistance at 2450, making a new high. Narrow consolidations and shallow corrections all signal investor confidence typical of the latter stages of a bull market. The immediate target is 2500* but further gains are likely.

S&P 500

Target: 2400 + ( 2400 – 2300 ) = 2500

The stock market remains an exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient.

~ Warren Buffett

Ludovico Einaudi – Primavera

New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well | WSJ

By Neel Kashkari:

Three strikeouts in four at bats would be barely acceptable in baseball. For a policy designed to prevent taxpayer bailouts, it’s an undeniable defeat. In the past few weeks, four European bank failures have demonstrated that a signature feature of the postcrisis regulatory regime simply cannot protect the public. There’s no need for more evidence: “bail-in debt” doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity.

Bail-in debt was envisioned as an elegant solution to the “too big to fail” problem. When a bank ran into trouble, regulators could trigger a conversion of debt to equity. Bondholders would take the losses. The firm would be recapitalized. Taxpayers would be spared……

The problem is that it rarely works this way in real life. On June 1, the Italian government and European Union agreed to bail out Banca Monte dei Paschi di Siena with a €6.6 billion infusion, while protecting some bondholders who should have taken losses. Then on June 24, Italy decided to use public funds to protect bondholders of two more banks, Banca Popolare di Vicenza and Veneto Banca, with up to €17 billion of capital and guarantees. The one recent case in which taxpayers were spared was in Spain, when Banco Popular failed on June 6……

The Minneapolis Fed President has hit the nail on the head. Conversion of bondholders to equity may be legally plausible but psychologically damaging. Similar to money market funds “breaking the buck’, conversion of bondholders to equity in a troubled bank would traumatize markets. Causing widespread panic and damage far in excess of the initial loss. Actions of Italian authorities show how impractical conversion is. Especially when one considers that the affected banks were less than one-tenth the size of behemoths like JPMorgan [JPM].

Banks need to raise more equity capital.

Source: New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well – WSJ

Australia faces headwinds

Australian wage rate growth, on the other hand, is declining. is in a worse position, with a dramatic fall in investment following the mining boom.

Australia: Wage Price Index

Source: RBA & ABS

As is inflation.

Australia: Inflation

Source: RBA & ABS

Growth in Household Disposable Income and Consumption.

Australia: Household Income and Consumption

Source: RBA & ABS

And Banks return on shareholders equity.

Australia: Banks Return on Equity

Source: RBA & APRA

But not Housing.

Australia: Banks Return on Equity

Source: RBA, ABS, APM, CoreLogic & Residex

At least not yet.

Falling house prices would complete the feedback loop, shrinking household incomes, consumption and banks ROE.

US adds 222 thousand jobs

From the Wall Street Journal:

U.S. employers picked up their pace of hiring in June. Nonfarm payrolls rose by a seasonally adjusted 222,000 from the prior month, the Labor Department said. The unemployment rate ticked up to 4.4% from 4.3% the prior month as more people joined the workforce…..

Job Gains

Source: St Louis Fed & BLS

Forecast GDP for the current quarter — total payrolls * hours worked — is rising, showing an improving economy.

Real GDP Forecast

Source: St Louis Fed, BLS & BEA

Declining corporate profits as a percentage of net value added (RHS) is typical of mid-cycle growth, while employee compensation (% of net value added) is rising at a modest pace. Peaks in employee compensation are normally accompanied by troughs in corporate profits…..and followed by a recession.

US Corporate Profits and Employee Compensation as percentage of Value Added

Source: St Louis Fed & BEA

Average wage rate growth, both for production/non-supervisory and all employees, remains below 2.5% per year. Absence of wage rate pressure suggests that the Fed will be in no hurry to hike interest rates to curb inflationary pressure.

Hourly Wage Rate Growth

Source: St Louis Fed & BLS

Which should mean further growth ahead.

India: Sensex bullish

Narrow consolidation around 31000 is a bullish sign for India’s Sensex. Breakout above 31500 would signal a fresh advance. Twiggs Trend Index and Twiggs Money Flow both indicate healthy LT buying pressure. Target for an advance is 33000*.

BSE Sensex

* Target: 31500 + ( 31500 – 30000 ) = 33000

Europe: DJ Stoxx 50 correction

Dow Jones Euro Stoxx 50 is undergoing a correction. Breach of medium-term support at 3500 indicates hesitancy but the primary trend remains upward. Twiggs Trend Index and Twiggs Money Flow both look similar, with a sharp decline in the last two weeks. Respect of support at 3400 remains likely and recovery above 3500 would suggest an advance to the 2015 high at 3800*.

DJ Euro Stoxx 50

* Target calculation: 3650 + ( 3650 – 3500 ) = 3800

The Footsie and DJ Euro Stoxx 50 display a similar correction. My bearishness for the former primarily stems from the Pound weakening against the Euro.