Since bottoming on October 2, the Australian All Ords share index has been bullish on short-to-medium term trend and momentum analysis. Its 10-day trend line has stayed above its 30-day one, but its MACD momentum oscillator has been slowing since mid-November and has been negative since December 2. After peaking last Wednesday, the index pulled back slightly on Thursday and Friday.
Medium-to-long-term trend analysis
Since October 20, All Ords index has been bullish on medium-to-long term trend analysis because its 30-day trend line has been above its 300-day one. The Coppock momentum indicator confirms the Australian share market crash of February-March (the first crash since 2007-09) is well and truly over.
America’s market
Notwithstanding America’s biggest political and health crisis in decades, its stock market is buoyant, thanks to the Covid-19 vaccine breakthrough.
The Dow Jones share index has drifted down slightly since peaking on December 4. For the past four days it has shown negative momentum on the MACD oscillator. Nevertheless, on short-to-medium term analysis it remains strongly bullish with its red 10-day trend line well above its green 30-day one.
The US share market’s medium-to-long term trend and momentum is still strong. As can be seen the Dow’s 30-day trendline broke above its 300-day trendline on July 15 confirming the end of America’s bear market and its V-shaped recovery.
Exchange rates
The Australian dollar has risen strongly against the US dollar. See next chart.
One reason may be that America is still succumbing to Covid-19, whereas Australia has conquered it.
On the other hand, the Euro is also surging against the US dollar and Europe has still to get on top of the pandemic. So, the pandemic cannot be the only explanation for US dollar weakness.
One possibility is that the relative pace of money creation by central banks is driving exchange rates. This can be gauged by the growth of total assets held by each central bank. The chart below shows the position for the world’s four major central banks, the US Federal Reserve, the European Central Bank, the Bank of Japan and the Peoples Bank of China. Note that this year the Fed has been more aggressively creating money than its major peers which could be contributing the debasement of its currency.
However, a comparison of central bank balance sheet expansions relative to the size of their national economies (i.e., nominal GDP) shows this cannot explain the demise of the US dollar relative to the Euro, Japanese Yen and Chinese Yuan Renminbi in 2020.
One possible explanation for the US dollar’s recent weakness is that Investors are betting that Republicans will retain control of the Senate, after the Georgia state runoff election for two Senate positions, which would make it difficult for the Democrats to pass the larger fiscal spending package they want. This could result in a weaker economic rebound in 2020. Also, if many Americans refuse to be vaccinated for Covid-19, further lockdowns may be necessary which would also undermine growth.
But this does not explain why the US dollar has fallen so sharply against other currencies since March. The most plausible explanation is that the US dollar rose too strongly between 2011 and 2015 and since then has simply been adjusting down to a more normal level against other currencies. See next chart which shows the US Dollar relative to the Japanese Yen over the last fifteen years.
Anyhow some analysts think the Australian dollar could keep rising against the US dollar in 2021, perhaps getting as high as US 80 cents. This would put pressure on the Reserve Bank to continue reducing interest rates by expanding its QE (digital money printing) to make Australia a less attractive destination for parking footloose money.
Last week the NSW Treasury Corp issued an AA+ rated bond for an annual yield of 1.48%, the highest on offer for any AA or AAA rated government security (currency or non-currency hedged) in the world. Little wonder that capital is pouring into Australia pushing up our dollar and making our exports less price competitive than previously. With China’s markets closing to Australian produce (except for iron ore), the Reserve Bank could act sooner rather than later in easing monetary policy further.
One risk is that central banks enter a race to the bottom in debasing their currencies to avoid their national exporters being stranded with too high prices relative to competitors. Such a “beggar thy neighbour” policy became rife in the great depression of the 1930s. That is why fiscal policy is so important going forward. Fiscal policy is the use of government revenue collection and expenditure to influence a country’s economy
If the world is in a liquidity trap (where even negative interest rates won’t attract significant borrowing for industry expansion as opposed to speculative trading) then the best hope of ensuring a sustained economic recovery post-Covid-19 is to lift aggregate demand for goods and services. A large capital works program to renew and enhance public infrastructure (for example roads, bridges, railways, renewable energy grids, social housing) as is happening at a state level in Australia could assist in this task.
Micro-economic reforms to lift productivity through changes to employment agreements, taxes, government regulations and other institutional arrangements will also be necessary, but these are politically difficult to introduce unless there is an economic crisis demanding urgent action or a boost to economic activity that makes citizens more receptive to policy innovations.
Conclusion
An ongoing possibility is a pullback of the US market, which looks extremely overstretched on both technical and fundamental grounds. The sharp fall in the US dollar vis-a-vis other currencies this year has commentators perplexed. It risks forcing all central banks to pursue negative interest rates to debase their currencies to protect local exporters.
If the world is in a liquidity trap, where cheap credit is fuel for asset speculation rather than new investment in expanding production, then greater effort will be needed to lift aggregate economic demand (for example increased public works spending) than reducing the cost of supply (labour, capital, land, tax and regulatory compliance).
That is not to say micro-economic reforms to industrial relations, taxes and regulations are not needed, but that they would be easier to achieve if unemployment was low and wages accelerating. Or if the economy relapsed demanding drastic policy changes because of TINA (there is no alternative). But another recession is in no one’s interest.
Of more immediate concern is worsening relations with China. This poses a serious threat to our mining, energy, agriculture, fisheries, forestry, tourist and education sectors. The exception is iron ore where China has no ready alternative supplier to Australia given the production problems of Vale in Brazil.
Notwithstanding these forebodings, both the Australian and US equity markets remain bullish on short-to-medium and medium-to-long-term trend analysis. The imminent arrival of three or more vaccines for preventing and curing the Covid-19 virus (Britain has already started public vaccinations as have Russia and China) has investors seeing a return to more normal conditions in 2021.
That along with government fiscal stimulus, central bank liquidity creation and the prospect of interest rates staying low for at least three years is what is propelling share markets at present. (As always, this is economic and market commentary, not forecasting let alone trading or investment advice.)
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.