The XJO is expected to edge higher on open this morning following another break higher in the U.S on Friday night. U.S futures have edged into the red.
The winds have perhaps changed for our market. Up until quite recently, we had been eager to price in U.S gains, sometimes even pre-empting them. It was an unusual time, and certainly not the norm for our market which typically has a modus operandi of being cynically sidewards and cautious. However, over the past week the U.S has continued to grind higher, with convincing and extended breaks into fresh highs. Our market has responded with little to no movement, or very meek gains. The top of our market is roughly 8,300, had we been following the U.S closely, we would be through that by now – however we are set to flirt with 8,250 this morning. Part of our hesitation this morning may be due to red futures, but it does feel like the status quo has changed.
We can possibly look to our two major sectors for answers: the financials (dominated by the big four banks), and the materials (our key miners). From roughly May through to September, our materials index (which represents about 25% of our market) fell about 20% thanks to key commodities like iron ore selling down significantly. Yet during that period our market continued higher, made fresh highs, and rallied about 7% overall. It was able to do this because capital flooded into the major banks. CBA, for example, rallied about 25% during the same period. In essence, our market was able to keep pace with the U.S thanks to the banks, and despite our miners collapsing.
Over the past month or so however, there had been a rotation from the overheated and arguably overvalued banks, into the miners. At one point, for context, CBA was the most expensive bank in the “developed” world. Their backs were getting sore from carrying our index, and it was only time before they corrected.
A few weeks ago, the Chinese government practically announced they planned on stimulating their economy, which typically means through building. This announcement pushed key commodities like iron ore back towards their highs in May, and our materials index alongside it. We likely saw a rotation of capital from the banks into the miners; CBA corrected (about 10% down), and BHP rallied about 20%. It was a quick rotation that lasted about a week. The miners never reached their May highs however, and the banks are still expensive and arguably well overvalued. This rotation caused volatility in our market, but largely kept it sidewards.
For the past week or so, we have seen the miners sell off – perhaps as a form of profit taking, or healthy mean reversion. However, that release of capital has not flowed back into the banks, which have experienced a small rally, but nothing significant. It is this lack of drive from our banks, the unwillingness from participants to buy into an arguably overvalued sector, that has kept our market from following the U.S in the short-term. If cynicism sets in, we will remain reluctant to follow them in good measure. However, keep in mind, if the U.S does keep making fresh highs, our index will be dragged along whether it likes it or not.
Wholistically, markets remain driven by key macroeconomic data. The battle around inflation verse recession remains the focus for medium to longer-term projections. The data releases however can spark short-term movement as evidence starts to build for one case or another. The week ahead is fairly quiet. On Thursday we have local employment data which is expected to remain sticky at roughly 4.2% (practically full employment). On Thursday night, the ECB is expected to follow the U.S and cut interest rates by 25 basis points. Also, on Thursday night the U.S will update retail sales numbers, which are expected to grow slightly (MoM) but remain marginal. To finish the weak, Chinese GDP is expected to come in slightly less than the same time last year. Coupled with their worse than expected inflation numbers this morning, this could help our miners find confidence again.
US Markets
US shares closed higher on Friday, with prices rising after stronger than expected earnings results, with JP Morgan, Wells Fargo, and Blackrock all rising after reporting better than expected numbers. Somewhat offsetting this was weakness in Tesla, which fell after a disappointing investor presentation. Other US economic data was also somewhat positive for markets, with lower than expected producer prices, which is a positive for the inflation story. This week is mostly a fairly quiet one for US economic data, with only Thursday holding key events in the form of Retail Sales and Jobless claims. Otherwise the week will be about company earnings reporting, which will continue for the next few weeks.
Ten of the eleven sector groups of the SP500 closed higher on Friday, with Financials the strongest performers, followed by Industrial, and Real Estate stocks. Most other sectors closed higher, with only Technology and Discretionary seeing selling.
Technically, the SP500 broke above the all-time high resistance level at 5,770 last week indicating further upwards movement, though its hard to say where that movement may rise to. 5,770 is now likely to act as support to the downside.
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