Wall Street surged on Friday. The S&P 500 jumped 3.4% while the NASDAQ soared 4.3%. Bear market rallies are like that. They are a mixture of short covering and hope that the bottom is in.
Short covering occurs when those who bet on a falling market buy back shares to lock in a profit. And buying on hope occurs because, for some reason, that’s what people do…
The catalyst for the rally was twofold. Employment data came in stronger than expected, and Fed Chair Jerome Powell eased back on the expected path of interest rate rises. From the Financial Times…
‘…on Friday stocks enjoyed a powerful bounce, thanks to better than expected US jobs data, and Federal Reserve chair Jay Powell sounding decidedly more dovish.
‘The non-farm payrolls data were a smash hit across the board. The headline number of jobs created, 312,000, beat expectations, as did wage growth and the participation rate.
‘Even the unemployment rate edging up was driven by previously discouraged workers entering the work force again, a positive sign. This helped soothe some of the concerns that the US economic slowdown could deepen into something worse.
‘Mr Powell then poured more fuel on the market rally by saying that the Fed would be “patient” in deciding on any more interest rate increases, and “wouldn’t hesitate” in pausing its balance sheet shrinkage if it was necessary.’
Stock prices are forward-looking. They try to predict the future, not the present. The market’s strong rally in reaction to the latest news tells you that prices had previously predicted a scenario that was too gloomy.
This is how bear markets work. Bad news, combined with fear, pushes prices too far to the downside. Central banks (whose job is to keep investor psychology positive) then respond and prices bounce back until more bad news pushes prices down again.
If the economic cycle has peaked (and I think it has) then more data will emerge in the coming weeks and months that demonstrate this reality. For now though, the market is relieved that the Fed might be on hold. This hope may sustain a rally for a little while. Use it to your advantage.
In Friday’s Rum Rebellion, I mentioned that there were an increasing number of bearish views on China. When that happens, you have to look for a counter-intuitive rally as it means much of the bad news is already in the price.
The catalyst for the China bears was Apple last week announcing a revenue downgrade on the back of weaker Chinese sales.
But soon after, footwear and apparel company Nike announced its China sales jumped 26% in the fourth quarter, to US$1.54 billion. That’s not exactly a bearish read on the Chinese economy.
That gave the bulls more confidence that the world economy isn’t slowing drastically. Which is true. But China isn’t a consumer economy. Its growth is still very much driven by infrastructure investment. So let’s take a look at a few key commodity prices to see how activity on that front is going.
Iron ore key indicator of China
The iron ore price is still probably one of the most important barometers of China’s economy. As the chart below shows, the iron ore price isn’t reflecting a huge amount of concern about China’s growth right now.
The price is around US$72/tonne. That’s well above the late 2015 lows around US$38/tonne.
My guess is that the trade war concerns with the US are actually helping the iron ore price. That’s because infrastructure growth, via state directed lending, is one way China can manage the impact of the trade war.
For example, just last week, the People’s Bank of China announced cuts to banks’ reserve ratio requirement, which increases their ability to make loans. As usual, much of this new loan capacity will probably go into fixed asset investment, which is good for iron ore prices.
What about copper? Well, the red metal is not looking as healthy as iron ore. The copper price is down considerably this year. It’s currently trading at US$2.65/lb, only just above the lows from mid-2018 and long term support (green line) around US$2.50/lb.
The trend isn’t looking good for copper. It’s bearish. If it can hold above US$2.50/lb, it will be a positive and suggest China’s economy is hanging in there. But a break below support would be a major concern. Let’s see what happens…
Lastly, let’s look at BHP Group Limited [ASX:BHP]. Below is a longer term chart showing the bear market decline, and bull market rally from the early 2016 low.
As you can see, BHP is trading close to long term highs. There really isn’t any China concern in this price. Given the worries about the US/China trade war and slowing global growth, such a view is extraordinary.
I happen to think BHP’s share price is topping out and will suffer further falls this year. But what would I know? That it’s outperformed strongly in an overall bearish market is a bullish sign. Robust iron ore and coal prices are obviously generating strong cash flow and the market doesn’t see a major change to this scenario.
Taken together then, the major China related commodities tell you that things aren’t too bad in the Middle Kingdom. It’s not motoring along, by any means, but it’s not slowing down at a rapid pace either.
As I said last week, longer term, China has many problems. But a centrally planned government can manage those problems in the short term, and that’s what markets react to.
Tomorrow, I’ll take a look at the non-commodity side of China’s economy and see what the market is saying on that front. Stay tuned…
Editor, The Rum Rebellion