The Pain Report provides you with a weekly independent and objective commentary on the global economy, in an attempt to help you identify the key forces which will shape the world in the years ahead. For example, I believe that the most significant and defining economic phenomenon of our time is the rise of the Asian middle classes. I urge you to beware the prism through which you view the world, and to be aware that much of the western media’s negative and sensationalist coverage is biased against the so-called emerging nations. In my view, the decades ahead will see an era of prosperity, enlightenment and opportunity that very few today are predicting. If any of the above resonates with you then please read "The Pain Report".
As many of you will hopefully know by now I pay a lot of attention to what the charts are telling me. And in the spirit of a picture paints a thousand words I cannot take my eyes off the charts below. The first chart shows the monthly moving average convergence/divergence indicator for the S&P 500. This was one of the indicators that made me so cautious as we entered the final quarter of 2015.
Some of you may recall my report at that time, which read as follows. “There is an unambiguously negative confluence of forces that threaten to tear the financial markets apart.” We then saw global equity markets fall sharply in January as that confluence of forces overwhelmed markets.
Now is perhaps a good time to remind ourselves what those forces were. In short they were: collapsing oil prices, Chinese debt levels, fears of a US recession, the perception that central banks had run out of ammunition and could no longer control markets, deflationary forces from the east and that China had lost control of their currency. Yes, it was a long list.
By February I suggested that markets were very oversold, and on 20 February noted that markets could move higher, saying the trend is your friend. Two months later it’s make your mind up time! Astonishingly enough we are now just 43 points away from the all-time high in the S&P 500.
S&P 500 Index MACD
S&P 500 Monthly index
Now is perhaps a good time to re-examine the factors, or forces, that 5 or so months ago, sent the market into a tailspin. Oil prices are 68% higher than their February low. Chinese debt is still the elephant in the room, but the authorities have unleashed a tsunami of credit to stimulate the economy, as can be seen in the chart below.
The fears of a US recession have clearly receded, with a range of economic indicators suggesting growth this year of about 1.5 to 2%. The issue of central banks losing their capacity to influence markets is, however, a more complex one. One could argue that both the ECB and BOJ have lost their perceived ‘omnipotency’ but this cannot surely be said about the FED. Indeed, two significant events can be seen to have had a profound influence on market psychology.
The downward revisions to the FOMC’s projections for the federal funds rate, the so-called dot plot, and then Janet Yellen’s speech at The Economics Club of New York. Both these developments assured markets that the Fed was in no hurry to raise rates, and the markets soared. Adding further fuel to the ascent of the market was China’s herculean efforts to stabilise their currency, which they successfully did.
Regarding the deflationary forces from the east, this remains a continuing concern of the market, and mine, albeit one that has been moved off the front page by all the aforementioned developments. So everyone is happy now, right? The bears certainly aren’t because they think the proverbial can has just been kicked down the road and are now even muttering about Greece again. I don’t know about you but I can’t bear the thought of more late night Greek dramas...so I’m keeping this report Greece free.
But interestingly enough the bulls are nervous too. Why? Well, first of all they totally missed the January meltdown and still don’t really understand what all the fuss was about. Then you have RBA Governor Stevens saying, at a speech earlier this week, in New York, “The relative calm seems a little eerie-perhaps fragile.” That comment certainly caught my eye. But, moving on from that rather out of character remark, perhaps it’s all much more simple.
Equities, in absolute terms, may not be cheap, but, in relative terms they are really cheap. And if you believe that the discount factor in your Net Present Value (NPV) calculation is likely to remain at negligible levels then stocks can be made to look cheap. Having said all of that you must surely agree that the world, simply, has too much debt. And most importantly, in my view, debt acts as a handbrake on growth.
This begs the obvious, and most important, question of them all and that is the sustainability of dividend growth. Which brings me to the issue of the dividends currently being paid by the Australian banks. You know by now that I see a 30% decline in nationwide Australian house prices (if you would like a copy of the latest Pain Report please contact us at 1300 750 007). This therefore means that we will, in my view, see the Australian banks cut their dividends by the end of this year, or in 2017. Only time will tell.
In the meantime, the S&P 500 may reach its May 2015 high, but I am becoming more cautious. I’m just not seeing the kind of earnings ‘validation’ that is required to take equity markets higher. I’ll develop this theme further in the weeks ahead.
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