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Protrader – August 2018 Market Wrap

//Protrader – August 2018 Market Wrap
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Looking into the future
What the rest of the year may hold
XJO
Prepare for severe turbulance.
Up 44 points for August

The Australian market was up over 44 points for the month of August and again hit a succession of new highs for the decade throughout the month.

However, it was a month of extreme volatility resulting in wild 142 point swings in the market. Such volatility often accompanies markets when reaching new highs, as the market psychologically adjusts to becoming comfortable with its new level.

Solid economic and corporate data was once again undermined by abstruse issues such as domestic political intrigue and potential expanding International trade war concerns.

KEY ECONOMIC DATA

  • Continued slide in base metals.
  • 48% of earnings beat market expectations
  • 83% of corporations reported earnings higher than 12 months ago
  • 89% of ASX listed companies have increased or held dividends constant
  • China PMI Manufacturing beat expectations.

                     DOW JONES IND AVG 25,461 – 25,964 : UP 503

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DJI 12 MONTH CHART

The month of August saw the Dow initially creep up, and then drop off and retest the important 25,000 level.

However from the 15th on, once again the sheer weight of phenomenal economic and corporate data compelled the market to override continued fears around political issue and a potential trade war, resulting in a rally from 24,966 to a peak of 26,122, with the S&P 500 reaching an all-time intraday high on the 21st, before succumbing to trade war and political concerns, finishing the month at 25,964.

The phenomenal corporate earnings season continued, with around 79% of S&P 500 companies beating market expectations. This earnings season growth has actually outpaced the market, which is a very rare event.

This stellar corporate earnings season coupled with simply breathtaking macroeconomic data, such as the GDP dramatically improving from 2.2% at the start of the year to 4.2%, and the US unemployment rate falling to its lowest level since 2000, at 3.9%.

The positive picture surrounding the underlying U.S economic growth is literally the best in a generation and is yet to be fully represented in share prices.

Key Developments in the Month of August

  • US unemployment rate 3.9%
  • Trade War escalation with China, expanding to $200b of tariffs
  • Continued positive domestic Economic Data
  • Expected likelihood rate rise in Sept, and a further Interest Rate increases in December.
  • EU trade dispute resolved.

                        OIL STOCK UPDATES: Massive upside potential

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WTI Crude – Gained $2.14 from $67.66 – $69.80

The WTI Oil price GAINED $2.14 for the month of August, although it could be fair to describe the month as volatile with unknowns such as Iran’s reaction regarding pending sanctions and the impact upon supply, against a backdrop of concerns over rising trade war tensions and emerging market troubles impacting upon demand.
These macro factors coupled with US crude Inventories and stockpiles unexpectedly jumping resulted in the WTI Oil price fluctuating over $5 during the month of August.

Key Oil Price Influences

  • Venezuelan production continued to decline
  • Moving into the business end of Hurricane season, potentially impacting upon production in the Gulf of Mexico
  • US Crude inventories are unseasonally high
  • West Texan Permian basin has physically reached “pipeline” capacity
  • Oil giant Total has completely withdrawn from Iran suggesting US sanctions will have an impact beginning in November
LOOKING INTO THE FUTURE: 2018 AND BEYOND

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XJO 15yr Chart

 

 

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XJO 50 yr Monthly Chart
Using the two charts above, the XJO weekly chart for 15 yrs, and the XJO monthly chart for 50 yrs, we can see the Australian Market has broken through a major resistance level of 6000, and on a solid trajectory to re-test the previous high, and head towards the 7000 level over the next 12 months. The recent solid earning season has supported the recent positive movement.

What is important to understand is that from a fundamental analysis point of view, the market is not expensive. Using the two charts below, Avg P/E, and Avg Dividend yield, we can see that the market from a 28 yr historical value is, at the very least fair value.ie: The fundamentals are supporting the charts.

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Furthermore, when one looks at the market in the context of Real terms (after inflation), the All Ords index is actually 27% below its 2007 peak. Although it should be added that using “real terms”, is contentious when valuing a market.

 

 

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Possible Headwinds
This now leaves us to look at both domestic and International factors that may derail or impact upon the strong market. Although as is the nature of markets it is often something that comes from left field that derails the market trajectory, therefore we’ll focus on known, knowns, as opposed to known unknowns.

Domestic Issues

Australia’s economy is presently very robust with the recently released GDP of 3.4% beating all expectations, and our unemployment rate the lowest in 6 yrs, all points to a healthy economy with interest rates set to rise early next year. However, the big concern is the housing sector, particularly in Melbourne and Sydney where housing prices are falling at the fastest rate since 2012.

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The prices falling by themselves is not the concern, it is the lending standards (or lack thereof) that the big four have been adhering too. From the royal commission, it became apparent that the big four had pursued the practice of outsourcing the mortgage vetting arm to 3rd parties, which may have lead to a degree of truth stretching.
This has now culminated in the likelihood of potentially 1’000’000 Australian households missing their mortgage payment in September, and being on a knife edge with their ability to be able to pay the mortgage in an increasing interest rate environment.
This may cause a spiral of forced property sales, which turns into a cascade, resulting with a housing market collapse and thus the general economy faltering, negatively impacting upon the market as a whole, with the banking sector in particularly being hurt.
Trade Wars

The US of recent times has tried to realign decades-old trade relationships and agreements, with threats from all sides regarding tariffs.
This will be resolved particularly the negotiations between the US and the EU and Canada.
What we don’t know is how the negotiations with China will finish, and how much collateral damage will be incurred by all parties before it is resolved. In addition, there is the great concern that an expanding trade war between China and the US would have an impact on world demand and economic growth.

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As one can see from the above chart, concerns about economic world growth is already being factored into the price of copper, which is generally considered as a gauge/guide of the world economy, until the trade issue is resolved, one would expect to see copper languish around 12-month lows.
EMERGING MARKETS CONTAGION

The most recent major international concern and threat to the Australian market, has been that of Emerging Markets collapse.
The narrative: Due to the strengthening of the US economy, the US dollar has gone up, resulting in a flight to safety by International investors (why not have your money in US dollars and get a good return, rather than a marginally higher return with greater risk, in an emerging economy) unfortunately all these countries have their sovereign debt in US dollars, creating a vicious circle as their repayments are in US dollars yet their own currency depreciates thus requiring more of their own currency to make the same repayment that’s in US dollars. The concern then is that the money has to come from somewhere such as govt spending, on construction, Infrastructure development etc. This then, in turn, puts more pressure on the local currency, and thus the cycle continues.
Individually it isn’t a concern, however, when you start to look at the possibility of a contagion and look at a basket of countries that may be affected, like China, India, Brazil, Turkey and Indonesia it becomes very clear that world economic growth and thus demand for Australian resources could come to a complete halt. Naturally, this would impact not only upon our currency but also for the resource sector and Australia’s economy and the stock market as a whole.
Conclusion

The world economy and particularly the US economy is very strong.

KEY HIGHLIGHTS

  • UK unemployment rate lowest since 1976
  • Germany the engine room of Europe better than expected GDP
  • US GDP dramatically better than expected
  • First-time unemployment claims lowest since 1969
The crux of the situation is that fundamentals are very strong and are yet to be really represented in the ASX. The threat of an expanding trade war between China and the US, cast a large shadow over the world economy and the Australian stock market. Once this issue can be resolved one would expect to see the shadow lifted and the market continues on the present trajectory with share prices supported by world economic growth. 
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