Since my last report, the All-Ords share price index rose by 3.2% from Friday 3rd May to Thursday 16th May, but then fell by 2.2% to Friday 31st May. But for a 0.9% uptick last Friday there would have been no gain in the last four weeks.
Market trends
My technical models show:
- On short-to-medium-term trend analysis the Australian All-Ords index is now bearish whereas the American S&P 500 remains bullish.
- On medium-to-long-term trend analysis both the Australian and US markets remain bullish.
- The Coppock momentum indicators of both markets are positive. They turned up in negative territory early last year signalling the previous bear market was over.
Market still directionless
Since my last report, the All-Ords share price index rose by 3.2% from Friday 3rd May to Thursday 16th May, but then fell by 2.2% to Friday 31st May. But for a 0.9% uptick last Friday there would have been no gain in the last four weeks.
Since the end of February when the market surpassed its previous high in January 2022, the All-Ords has wobbled sideways.
Economic news
Two factors contributed to the sharp market pullback in April.
Rate worry
First was the growing concern that both the US Federal Reserve and the Australian Reserve Bank may not cut interest rates until 2025 because their inflation fights have stalled. The strong rise in share prices after last November was based on investor confidence that the US cash rate would start falling in March 2024 and be 1.5% lower by year’s end. Because investors thought interest rates would fall, they rebalanced their portfolios from low-risk cash and bonds into riskier assets such as shares that offer a better long-term return. With these hopes dashed, they then switched back to defensive assets.
War fears
The second reason for the market’s pullback was that the Gaza War could escalate into an Israeli Iranian war following the tit-for-tat attacks by each country after Israel bombed the Iranian embassy in Syria on 1 April. Adverse surprises such as runaway wars are known as “black swan” events. Investors tend to go from “risk on” to “risk off” on such occasions shedding shares for cash, gold, or treasury bonds as a safe refuge. However, war fears eased after both Iran and Israel declared they would take no further military actions for now.
Fed caution
From the start of May, the market mood improved largely because the US Federal Reserve Chair Jerome Powell maintained a cautious stance, emphasising the need for additional data before considering policy changes. This approach reassured investors and underscored the importance of data-driven decisions.
Other encouraging news in the first half of May was US data showing:
- Orders for durable goods rose 0.7% in April, beating expectations. This positive economic indicator contributed to the market rise.
- The consumer price index inflation rate was a seasonally adjusted 0.3% in April, maintaining the annual inflation rate at 3.4%. This lower-than-expected outcome suggested interest rates should eventually fall.
- The seven major hi-tech companies known as the “Magnificent Seven” (including Nvidia, Microsoft, Meta, Amazon, Apple, Alphabet, and Tesla) performed well on the promise of enormous benefits from artificial intellignce (AI).
Mixed data
The fall in the second half of May can be attributed to conflicting data on whether the US economy and with it inflation were strengthening or weakening:
- The US purchasing managers index indicated rapid economic growth that could reignite cost pressures and delay interest-rate cuts.
- The University of Michigan’s US consumer sentiment index showed that Americans grew gloomier this month.
- The Conference Board’s leading indicators index fell by 0.6% in April, signalling a weaker U.S. economy in the coming months. This decline followed a drop of 0.3% in March, indicating economic softening.
- The core Personal Consumption Expenditures (PCE) price index, which is the Federal Reserve’s primary inflation rate, decreased from 3.7% to 3.6% in the first quarter of 2024. While welcome this small fall suggested that inflation remains sticky.
- The Bureau of Economic Analysis revised the first-quarter U.S. gross domestic product (GDP) growth rate to 1.3% (annualised), down from the initial estimate of 1.6%). Treasury yields declined in response to the GDP revision.
May madness
There is a Wall Street saying – sell in May and go away until St Ledgers Day. That is because historically the period from May to October has shown lower monthly gains than the period from November to April. See chart below.
Source: https://tradethatswing.com/seasonal-patterns-of-the-stock-market/
The “up-down” market result for May could be the start of that subdued seasonal pattern typical of the northern summer/autumn months. Or it may just reflect short-term market schizophrenia, a split view of the future that investors cannot reconcile.
Investors want lower interest rates because that would boost equity and property prices. But to get annual inflation down to 2% (the Fed’s target and that of many other central banks) might require not just keeping rates higher for longer but raising them further. That would cool the economy and with-it corporate earnings.
At present investors are torn between wishing for an immaculate disinflation where the economy remains strong with inflation comes back within target and a fear that the Fed will grow impatient with sticky inflation and apply the brakes to economic growth to bring inflation to heel.
Big picture
Three months ago, the All-Ords index finally escaped its straitjacket of see-sawing sideways below 7,900 since April 2021. Bulls were ecstatic saying this proved the share market had overcome its previous channel gyrations and was free to climb even higher. But the journey since then has been ragged, with the index retreating after each advance, falling in April and now again in May. See circled part of next chart.
Bulls versus Bears
Bears say the All-Ords strong rally since the end of October 2023 could now end in a correction or crash since it was based on a false premise that the inflation fight was over so official interest rate cuts were imminent. Bulls claim the stalled progress on inflation is temporary since elevated interest rates should weaken the labour market thereby reducing wage push pressures on services inflation, the main bugbear. Bears retort that there is no sign that unemployment is rising sufficiently to stymie high wage demands.
Bulls point to US GDP which shows America’s economy is quickly slowing which should dampen inflation and thereby allow rate cuts. Bears warn that the same data shows GDP inflation is accelerating so suggests America is slipping back into stagflation – higher inflation with weaker economic activity. If so, it presents the worst of both worlds since it would prevent rate cuts and depress corporate earnings.
Also, Australia’s latest CPI data points to higher inflation. If the March quarter GDP data proves dismal that too could also raise concerns about a stagflation outlook. Bulls say that looking in the rear vision mirror is no guide to the future. The pandemic inflationary shocks are over, and a cooling US economy is welcome since it has been running too hot compared to other developed countries.
Fundamental analysis
US commercial bank’s spare cash held with the Federal Reserve continues to remain elevated indicating adequate liquidity in financial markets which should provide support for stocks and bonds. See chart below.
Also, US financial conditions continue to stay loose by historical standards. See next chart.
Globally, financial stress is absent suggesting no imminent world-wide credit squeeze. See following chart.
The OECDs composite leading economic indicators are recovering for the seven largest developed economies (G7) but continued to fall for Australia though may be levelling off. See next chart.
OECD composite leading economic indicators for G7 economies
Source: https://data.oecd.org/leadind/composite-leading-indicator-cli.htm
The best gauge of whether a share market is over-priced and hence primed for a correction or crash from an external shock (e.g. credit squeeze, oil price rise, world war, global pandemic, or other surprise ‘black swan’ event) is Professor Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio.
This ratio divides the current total capitalisation of a share market index by its total real earnings over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.
It is difficult to obtain the Shiller cyclically adjusted CAPE ratio for the major share markets other than the USA. Siblis Research calculates it for a dozen nations each six months, the latest being for 31st December 2023. See Chart below.
Source: https://siblisresearch.com/data/cape-ratios-by-country/
Most share market indices (especially America’s) have risen strongly since the end of December 2023, with Australia’s All Ord’s index being the exception. Hence the CAPE ratios above would have risen since then, but less so for Australia.
Based on the December 2023 CAPE ratios the US share market looks overstretched on valuation compared to all other markets except India and Japan. By contrast Australia’s stock market at 19.9 was above its historic average of around 17.0, but not excessively so.
In the following chart Van Eck calculates that the Australian share market in February 2024 was fairly valued compared to its average CAPE ratio historically whereas the US share market was significantly overvalued.
Bulls say the US share market has a high CAPE ratio because it is overweight in hi-tech companies that exhibit fast growth and so are not value stocks. Bears say historically markets with excessive CAPE ratios always correct to their historic mean and the US market will not prove the exception.
Note that CAPE ratios can remain elevated or depressed for lengthy periods so are not a reliable market timing tool. For example, the US market has been overvalued on its CAPE ratio since 2017 yet has been the strongest stock market globally over that period.
Trend analysis
Australia’s Market
On short-to-medium-term trend analysis, the All-Ords index is now bearish since its red 10-day trend line has fallen below its green 30-day one. Its price momentum as measured by the MACD has been negative for the past four trading days.
Observe that after being bullish for five months the All Ords went bearish on the 17 April, then bullish again on the 8 May, but has now gone bearish again. This suggests investors want rates to fall but fear this could be at the expense of growth and earnings. In other words, they want immaculate disinflation, but are not sure that is possible.
On medium-to-long-term trend analysis, the All-Ords index remains strongly bullish. Its green 30-day trend line remains well above its blue 300-day one.
Unlike America, Australia’s stock market during most of last year swung sideways because it has few tech stocks promising new riches through AI (artificial intelligence). However, the All-Ords like the S&P 500 has enjoyed a strong rally since October 2023 but for sharp pullbacks in January and April 2024.
The All-Ords dark green Coppock (COP) momentum indicator bottomed at the end of December 2022 and thereafter trended up into positive territory where it first wobbled before ascending higher.
In the past whenever the Coppock turned up in negative territory it signalled the end of an Australian bear market. Only end of month readings are meaningful since the Coppock is a monthly based index.
America’s market
The Australian All-Ords index is highly correlated to the American S&P 500 index as shown by the following chart. About 70% of the All-Ords movements are in synch with the S&P500, meaning only 30% is decided by local or foreign events not impacting the USA. Hence the importance of tracking what is happening on Wall Street’s stock exchange.
America’s S&P500 share index is bullish on short-to-medium-term trend analysis since its red 10-day trend line remains above its green 30-day line. Its MACD momentum indicator has been negative for the past three trading days.
The S&P 500 index’s medium-to-long-term trend went bullish on 14 April 2023 after the S&P 500 share index’s green 30-day trendline rose above its blue 300-day trendline. It became extremely bullish after its 10.3% correction in August to October 2023. It remains so notwithstanding its temporary pullback in April 2024.
The dark green S&P 500 Coppock (COP) momentum indicator turned up at the end of March 2023 and thereafter has continued rising and is strongly positive which confirms that the previous US bear market is well and truly over. Only end of month readings count for the Coppock since it is a monthly signal.
Percy Allan AM was Chair, Evidence Based Policy Research Project (2018-2022). He is also a Visiting Professor at the Institute for Public Policy and Governance, University of Technology Sydney. (Former Secretary, NSW Treasury and Chair, NSW T-Corp 1985-1994 and Chair, NSW Premier’s Council on the Cost & Quality of Government, 1999-2007)