ASX Breakout!

ASX 200 bullish market

In yesterday’s essay, I finished off by saying that the lack of inflationary pressures in the US means monetary tightening will be slower than expected, and this would provide support for stock prices.

You can make a similar argument for Australia. In recent weeks, the pace and quality of economic expansion has come under a cloud. Specifically, we got two straight months of negative retail sales growth. That doesn’t exactly paint a picture of a robust economy that can absorb a series of rate hikes, does it?

The market knows this. That’s partly the reason behind its strong recent rally and breakout from a lengthy consolidation phase. You can see the breakout in the chart of the ASX 200, below:

ASX 200 17-10-17
Source: Optuma
[Click to open new window]

The Aussie market has been trapped within a narrow range for the past five months. On 4 October the poor retail sales data came out and the market sold off. But it held at support levels (green line). On 6 October stocks rallied, and the market hasn’t looked back since.

I may be confusing correlation for causation, but in the absence of any other supporting news to push the market higher, it makes sense that a more cautious RBA (thanks to perceived consumer weakness) is behind the latest rally.

And the market reacted by sending consumer exposed stocks higher. Check out the index of consumer discretionary stocks over the past 10 days:

index of consumer discretionary stocks CAP 17-10-17
Source: Optuma
[Click to open new window]

The consumer staples index looks similar. Financials, industrials, energy stocks and resources are also moving higher.

The sectors that aren’t really joining in are the property trusts, telcos (stay away from this sector, it looks awful!) utilities, and gold.

Which is strange. Apart from telcos, the other sectors should all benefit from the perception that official interest rates will be lower for longer. But that’s not happening.

That means I may indeed be mistaking correlation for causation. For example, the bond market hasn’t rallied in recent weeks, meaning bond yields haven’t fallen much.

When investors sense economic weakness, bond yields generally fall. This in turn increases the relative value of interest rate-sensitive sectors, like property trusts and utilities.

The conclusion to draw from these contradictory signals is that the Aussie economy is still in reasonable health. However, concern over consumer spending will keep the RBA on hold until it really needs to move. 

One thing that will force its hand is higher inflation. But it will probably give inflation time to build instead of reacting straight away. This is why the bond market isn’t rallying along with stocks.

Keep in mind this is all hindsight analysis. I’m trying to put the pieces of the puzzle together by assessing what has already happened.

And there are probably pieces that I don’t even know about. So we’re looking at a puzzle similar to the one I try and get my kids to do from time to time. That is, you can make out the gist of it, but it’s incomplete, with pieces missing…under the bed or shoved in some crevice.

But when in doubt, follow the money. And the money is going into consumer related stocks, industrials, financials, energy and resources. So keep that in mind when picking stocks to invest in.

Oh, and there’s one last sector I want to show you today. It’s the small-cap index. I’ve mentioned this before, and pointed to its relative strength as a reason to be bullish on the market overall.

As it turned out, the small-caps did indeed lead the market higher. In fact, the Small Ordinaries index is now at its highest level since 2011. That’s impressive.

Small Ordinaries index 17-10-17
Source: Optuma
[Click to open new window]

The rally looks to have gone too far, too fast. So I’d expect a pullback in the short term. But a bullish breakout to six year highs is a very positive move. When capital flows into small stocks in such a convincing way, it tells you that something is going on. You shouldn’t ignore it.

The next challenge for the ASX 200 is to breach 6,000 points. The index hasn’t been past this point since the crisis of 2008. It might take a few more months to get there, but I think it will eventually do it. Let’s wait and see.

In the meantime, the psychology of the US market is worrying. Don’t forget, this market is way ahead of ours. And you can tell…as this Bloomberg article points out…

Sure, it’s an uncertain world out there, but fear invariably turns into greed, and the fear of missing out overshadows any anxiety about the next crash. That tends to quickly draw money back into the market every time it wobbles, despite legitimate worries about high valuations. “We certainly all joke about it: Buy the dip, that’s what we’ve been conditioned to do,” says Benjamin Dunn, president of the portfolio consulting practice at Alpha Theory, which works with money management firms. “Now you kind of have to do it. It’d almost be irresponsible not to.”

Hmmm…I’ll come back to this tomorrow. Stay tuned…

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan

Greg Canavan

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

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