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Who will drive the stock market in 2020 – America or China?

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China’s short term economic prospects are dimming, while America’s are brightening. American tariffs have already stunted China’s exports and though Trump has postponed further tariff increases, he has not removed those he previously introduced. But the immediate risk for China is its coronavirus outbreak.

China is considering cutting its 2020 economic growth target as the epidemic spreads beyond Wuhan. Bloomberg Economics expects China’s annual rate of GDP growth to fall from 6% to 4.5% in the current March quarter. The Peoples Bank of China has responded by pumping 1.2 trillion yuan (A$260 billion) into the banking system to steady the economy and share market.

Australian exports such as iron ore, LNG, coal, seafood, dairy, grains and meat depend heavily on the Chinese market. Our tourism industry hosts 1.5 million Chinese visitors a year and Australian universities have 100,000 Chinese students.

Australia’s prolonged drought, intense bushfires and now disruptive floods have shaken both business and consumer confidence. Stagnant real wages combined with record high household debt have made consumers more savings than spending conscious. Business in turn has been reluctant to invest in capacity expansion. Hence the local economy is relying more on exports than local demand to keep growing.

By contrast America’s economy is going gangbusters, thanks to the Federal Reserve pumping a record level of liquidity into financial markets and Donald Trump tolerating a federal government deficit of US$1.1 trillion; double that of his predecessor.

Increased jobs and wages have lifted US consumer confidence. In this upbeat climate, the scale of “margin debt” (buying shares by borrowing against them) is twice what it was in the last two stock market booms. See next chart.

Don’t fight the Fed

The cardinal rule of central banks is to remove the punchbowl before the party gets too boisterous. But Jerome Powell, the Governor of the US Federal Reserve seems determined to avoid any more barbs from Donald Trump by placating him with a frothy economy in the run-up to the November Presidential election.

The chart below shows how recent “repo purchases” by the Federal Reserve Bank represent the greatest injection of liquidity into financial markets in recorded history. This is the real reason that the US economy is buoyant and the stock market is on fire.

America’s stagnating profits

Yet US corporate profits (before tax) are declining, while their debt is growing as they borrow to buy back their own shares to boost earnings per share and thereby the share price itself. This is financial engineering on a grand scale that is not sustainable. As shown in the next chart, the two previous occasions when profits stalled the share index crashed and the economy experienced recession.

 

Watch liquidity not GDP

Share markets in the short term are driven by bank liquidity and interest rates rather than economic conditions. If you think quarterly GDP growth drives the share market, think again. There is no relationship between short-term economic performance and market result. Here’s what one study found: “Contrary to conventional wisdom, and what may be a surprise to those who see low single-digit rates of gross domestic product (GDP) growth as incompatible with solid double-digit stock market gains, GDP does not have to be booming to produce solid gains in the stock market… In fact, there is little relationship between the magnitude of GDP growth and stock market performance.

Source: The business Insider  


When the economy strengthens, the market expects higher interest rates and tighter credit conditions, which are poison for share prices. By contrast, when the economic outlook is weak, central banks ease monetary policy and governments expand spending, which boost share prices.
 

My conclusion

The Australian market is likely to follow both the American and Chinese stock markets, which should be upbeat as China spends to avert a crisis of confidence and America spends to pork barrel its election. But watch for market pullbacks whenever the US stock index overreaches on its short term trend and momentum. Also the possibility of “black swan” events can’t be ignored.

So to be on the safe side, I will continue to follow Market Timing Australia’s strategy signals as insurance against a bear market.

As my friend and veteran US market timer James O. Rohrbach likes to say: “There are only two good feelings in investing. One is being in the market when it is going up, and the other is being out of the market when it is going down”.

 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

Percy Allan co-founded Market Timing Pty Ltd in March 2009 and since April 2019, Switzer Financial Group will be publishing Market Timing Australia. All prices and analysis at 13 February 2020. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.