Watch These Two Sectors for Signs of Recovery
Monday, 20 April 2020
By Greg Canavan
I mentioned last week that the role of the market is to confound as many people as possible.
Which it continues to do…
Stocks rallied again on Wall Street on Friday. The Dow was up another 3%. The NASDAQ is now UP for the year!
Yes, a lot of people are incredulous. Yes, the market has probably gone too far. But that’s what markets do…always trying to confuse and deceive.
And let’s be honest. The sharp move higher isn’t completely insane. I mean, last week the US Federal Reserve started buying junk bonds.
If there is a better way to tell punters to buy any old financial asset without regard for fundamentals, I’m not sure what it is.
As Jonathan Tepper wrote in the Financial Times:
‘…last week we witnessed unprecedented moves by the US Federal Reserve to buy low-rated bonds and even exchange traded funds of junk debt. Markets reacted with glee at being rescued yet again. One strategist on Wall Street even called it a “gift from the Easter bunny”.’
I don’t know about you, but the Easter bunny gifts in my house didn’t last long. I suspect it will be the same for this rally.
The Aussie market is struggling today. In early afternoon trade, the ASX 200 is down around 0.7%.
Recall that chart I showed you last week. Here it is again, below (although not including today’s moves). It shows the ASX 200 trading around an area of strong resistance. The green line is the low from 2018, while just above there, at 5,545 points, is the 38.1% Fibonacci retracement level.
Today I’m not going to talk about how far stocks might bounce, or when the sell-off might resume.
Instead, I want to focus your attention on some bigger picture analysis.
We all know the Fed can have a major short-term impact on stock prices. But what is more important than looking at overall indices is to look at some key underlying sectors.
Doing so can give you an idea of what is REALLY going on in the economy.
Watch these two sectors for signs of recovery
With that in mind, let’s have a look at two economically crucial sectors.
Can you have an economic recovery without the banks joining in?
Banks create credit. In the modern monetary system, bank-created-credit is the source of all economic activity. If the global economy is past the worst of the COVID-induced slowdown, and starting to recover, you really want to see the banks doing well.
Is that happening now?
Let’s take a look…
The first chart shows the ASX 200 Financials Index.
The important thing to look at here is the lower panel of the chart. It shows how the financials (mostly the big banks) have performed relative to the index, the broader ASX 200. The green line shows relative performance. The red line is a simple moving average showing the short-term trend.
This chart tells you that the banks underperformed on the way down (meaning they fell harder than the overall market) and continued to underperform during the rebound (they rallied less than the overall market).
This is a poor sign. Apart from telling you to avoid the banks, it’s also telling you the economy is in poor health.
Is this just the situation in Australia?
No. Take a look at the US. The chart below shows the financials in the US badly underperforming the S&P 500. So the US economy is clearly in the doldrums too.
Return of the PIGS
It’s the same situation in Europe. That is, banks badly underperforming the broader index…
In fact, European banks have hardly enjoyed a bounce at all. That tells you you’re probably going to be hearing about the ‘PIGS’ again. You know, Portugal, Italy, Greece and Spain. After enjoying a long bull run, government bond yields in these markets are on their way back up again. That’s despite the European Central Bank (ECB) buying heavily in recent weeks.
These charts tell me that the recent market rally is largely speculative. It’s not grounded in any genuine evidence that the global economy is improving.
As we’re only a few months into this thing, that’s not surprising. But clearly, thanks to the Fed and global central banks, punters are pre-empting better days ahead by buying now.
In my view, that’s a low probability call. At the very least, you want to see signs that banks around the world are at least no longer underperforming. We’re certainly not there yet.
US oil price at 18-year lows
The other critical economic barometer is the oil price. In US trade on Friday, the US oil price plunged 8% to an 18-year low. The international oil price, Brent Crude actually finished up nearly 1%. It’s holding just above its early 2016 lows.
The divergence between US and international oil prices tells you that US production is still too high given the prevailing economic conditions. Many of those shale oil producers, buoyed by years of easy money, will have to stop producing.
While Brent Crude has been more resilient, as you can see from the chart below, it has underperformed the S&P 500 too.
The upshot of all this?
Until you start seeing some decent relative performance from these economically sensitive sectors, you can take this rally with a grain of salt.
Also, watch out for high European sovereign debt levels to return to the headlines. European banks own a lot of this debt. If the market starts to lose confidence in Italy or Spain, bond yields on their debt will start to rise (meaning bond prices will begin to fall).
That will be a further blow to the banking sector. How much of this dubious sovereign debt will the ECB be prepared to buy?
We could see another existential crisis for the euro this year.
All this doesn’t mean the market can’t keep rallying in the short term. But just remember, there is little evidence of fundamental support for higher share prices right now.
I’m not buying this rally…
That’s all from me today. Please continue reading below for you ‘Week Ahead’ video from Pivot Trader editor, Murray Dawes.
Bumping Up Against Resistance
By Murray Dawes
Before I get started, I’m pleased to let you know that you have another chance to view the recent video workshops I put together with Simon Munton.
If you have been watching my ‘Week Ahead’ videos and are interested in learning more about the theory behind my approach to trading, you should check them out by going here.
They’re only available until this Thursday and it’s completely free to check them out. You will be given access to some of my proprietary intellectual property that has taken decades to develop, so don’t miss out if you are interested in trading.
In my last ‘Week Ahead’ video two weeks ago called ‘Here Comes the Short Squeeze’, I said that we were probably going to see a big rally. That week saw the biggest rally in the S&P 500 since 1974.
I now think the rally is starting to get long in the tooth and we should see prices bumping up against some pretty stiff resistance before long.
In today’s update I show you the key zone in the E-mini S&P 500 futures where I will be very interested in putting on short positions or hedging current exposure. It is based on looking at multiple ranges and zeroing in on the sell zone of each.
When you combine them all together, you can find an area where probabilities will be highest of executing a trade with solid risk/reward and a good chance of success.
There is an added filter that needs to be ticked off before I will enter trades. I need to see a sell pivot within the key range on the daily or weekly charts before I will be allowed to consider entering positions.
By combining the knowledge of where markets often change direction with knowledge of how markets change direction, you can gain a solid edge. Just sign up for the free workshop above and you will learn how and why I trade the way I do.
The work I do with members of Pivot Trader is based on the theory that I show you in these weekly updates, but I apply it to stocks on the Australian Stock Exchange.
Editor, Pivot Trader