Markets bounced overnight. The Dow rose 0.64%, while the S&P 500 jumped 1%. Oil continued its crazy volatility, soaring 5%. Gold fell back a bit, quietly continuing to consolidate.
If you stand back from the daily noise, things are getting interesting. The Dow Jones index, always a good proxy for global stock market sentiment, is approaching an important point.
As you can see in the chart below, the rally from mid-February has been strong. The index bounced from a low of around 15,500 points to 17,800, a jump of nearly 15% in less than two months.
Now the rally looks tired.
The Dow looks like turning down again. If it does turn down from here, it will mark another ‘lower high’ on the chart.
A series of ‘lower highs’ is a bearish development. It tells you that momentum is stalling. If stocks do turn down from here, it suggests we’re in for another bearish phase.
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But it could take many weeks to play out. That’s why listening to the daily noise is dangerous. You need to learn to filter out a lot of stuff.
For example, in early November last year, the Dow also looked like topping out. At the time, I wrote this in The Daily Reckoning:
‘When a market has a sharp fall from a peak, as happened in August, you ALWAYS get a rebound. The strength and duration of the rebound reflects the strength of the overall market.
‘If the market DOES turn down from here, it will represent a lower high within an existing downtrend. That’s bearish.
‘Put another way, what you’ve seen is the Dow selling off and rebounding. But the rebound will most likely fail to make a new high. As I said, this is a bearish development.
‘So I’m tipping you’ll see another bout of weakness in US markets, and by extension, weakness in Aussie stocks too.’
Well, the Dow did sell off sharply soon after I wrote that. Then it bounced back. It continued with the volatility until the end of the year, before really tanking. It took another two months after I wrote that for the bear to really assert itself.
The point here is that the market can confound you in the very short term. It never does what you expect. So while I think we’re at another inflection point, I’m ready for the market to confound me for some time yet.
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But the Australian share market is a different beast. The ASX 200 threw in the towel on its rebound a few weeks ago. It’s at risk of heading back to new lows. That’s what happens when you have a market highly concentrated on financials.
Highly concentrated is an understatement. The financial sector accounts for nearly 45% of the ASX 200. Materials, or resource stocks, only make up 13% of the index. Admittedly, property trusts are part of the broader financials index but, when you think about it, there’s a reason why they are considered ‘financials’.
That’s because they are very interest rate sensitive. They’re like bonds. When interest rates fall, property trusts collectively go up. When interest rates rise, property trusts fall in price.
Anyway, when nearly half the Aussie share market consists of financially sensitive stocks, you know there is a problem.
Earlier this week, I wrote about the huge amount of private sector debt in the Australian economy. And it just keeps getting larger.
According to data on the RBA’s website, at the end of March, private sector debt stood at just over $2.5 trillion. By comparison, in March 2008 it was $1.8 trillion. So we’ve added around $700 billion in private sector debt since the crisis. (That’s not even taking into account the huge jump in government debt over this timeframe.)
Let’s put these numbers in context. The most common way of doing so is to compare it to economic output. The chart below does that. It shows the ratio of private sector credit to Australia’s nominal economic output (which is GDP not adjusted for inflation).
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As you can see, since roughly 2011, the ratio has climbed sharply. What that means is that private sector debt is growing faster than nominal economic growth. In fact, we’re heading back towards the peak reached in…2007.
When you consider this information with what’s happening in the Aussie stock market, it’s a bit of a worry. That is, private debt is at its highest level in history. They’re approaching their all-time highs, relative to economic output.
Yet the stock market, which is laden with financial companies reliant on this debt, continues to languish.
That tells me that the debt expansion of the past few years has been increasingly unproductive. It’s not leading to increased share market profits. It’s not leading to higher levels of nominal economic growth.
That’s what happens in a Ponzi scheme. That is, an increasing proportion of new debt goes towards financing existing debt, rather than productive enterprise.
The Australian economy is slowly succumbing to the disease that afflicted the US and Europe. Those economies took on too much debt at all levels and are still suffering the consequences. They are stuck in a low growth nightmare that years of central bank tinkering cannot fix. In fact, the supposed remedy is just making things worse.
In years gone by, a recession would clear out the ‘underperforming loans’, like a bushfire clearing out the deadwood, and growth would renew. Not anymore though. Bushfires have been so successfully avoided that the only assurance is a massive future conflagration.
Central banks are just adding more fuel…fuel awaiting a spark.
Against this backdrop, the circus that is Australian politics right now is sadly entertaining.
For Markets and Money