Technical Analysis

Why stocks are at record highs – Can the good times last?

Thu 06 Jun 24, 3:49pm (AEST)
party time
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Key Points

  • Several global stock indices, lead by the USA’s NASDAQ Composite Index are at or very close to record highs
  • The interest rate outlook has improved markedly over the last few days after a benign inflation print in the USA
  • The technicals suggest strong demand and limited supply for US stocks is only partially being reflected in the Australian stock market, but this might change if a certain technical signal occurs

If you feel like the last few weeks in markets have been a little schizophrenic, I feel your pain. Fortunately, after a choppy May for most major stock indices, global equities appear to be on the rise again.

Why the sudden burst of exuberance in global equities? The answer to this question is nearly always: It’s all about interest rates.

Interest rates represent the price of money. The price of money influences the prices of all other assets. Generally, if money gets cheaper, it’s easier for investors to use it to buy assets, like stocks.

Put simply: Stocks love lower interest rates. It’s good for company profits (higher consumption by us and lower funding costs), and lower rates reduces the discounting applied to future profits in the valuation equation. Lower rates support higher stock valuations.

US 10-year T-Note yield 5 June 2024
US 10-year T-Note yield

Thursday marked the fifth straight decline in the key global interest rate benchmark – the yield of the US 10-year T-Note. It dipped from 4.64% to 4.28%, a decline of 0.36% or 36 basis points (bp). Bond prices move inversely to yields.

Given the US Federal Reserve (and our own RBA) usually deal in 25 bp moves, investors have effectively applied nearly one-and-a-half standard rate cuts to market rate pricing. It’s important to remember that the Fed has done absolutely nothing, and it's under no obligation whatsoever to follow the whims of investors.

The trigger for the sharp decline in market yields was last Friday’s Core PCE data which showed a stagnation in US inflation. Many investors were expecting it to show a pick-up, and the fact it didn’t, has brought forward expectations for the first Fed rate cuts.

The improved interest rate outlook is having a big positive impact on stock prices.

NASDAQ Composite Index 5 June 2024
NASDAQ Composite Index

Arguably the stock index that stands to benefit the most from lower interest rates is the NASDAQ Composite Index in the USA. It contains nearly 5,000 stocks whose businesses are skewed towards higher growth enterprises, particularly those related to technology.

Many of these companies rely heavily on debt to fund their growth, and many are pre-earnings with those earnings forecast into the distant future. Lower rates help greatly with a company's debt funding, as well as discounting those distant future earnings by investors.

We often call assets with returns skewed to the future as “long duration”. Long duration assets do the best when rates fall and vice versa.

Thursday saw the NASDAQ blasted to yet another record high, powered by a strong move in major technology stocks like NVIDIA, Amazon, and Microsoft.

From a technical standpoint, this chart is about as good as you can get. Short and long term trends, rising peaks and rising troughs (price action), and predominantly white-bodied candles and or downward pointing candle shadows (demand-side candles), indicate total demand-side dominance.

Good technical analysis doesn’t seek to predict, but merely react based upon analysis of the trends, price action, and candles described above. If the NASDAQ printed an all time high and is on the verge of collapse, it will not be evident in the technicals but it absolutely could be the case.

All I can say as a trend following technical analyst is that in my experience, the balance of probability lies with perpetuation of the prevailing demand-side environment.

One thing I can say with absolute certainty, is that it appears from the technicals that investors are converting cash to shares, and shareholders are holding on for more.

I must assume that they’re doing this for good reasons, and that they’re doing this because they perceive further gains in the future (otherwise why do it!?).

Things can change quickly in the market, in the global economy (remember the pandemic?) and tomorrow may well start the next bear market. I won’t know until I see the trends change from up to sideways, the price action to falling peaks and falling troughs, and the candles to black bodied and or upward pointing candle shadows.

I will worry about it when it happens. For now, my job is to just trust and follow the trend.

The Australian experience

Bringing it back home, the local interest rate picture has also improved markedly. The chart of the benchmark Australian Government Bond yield looks very similar to its US counterpart. The yield here has fallen a more modest 27 bp from the recent 4.48% peak – but it’s still more than a full RBA rate cut priced in.

Australia 10-year Government Bond yield 5 June 2024
Australian Government Bond yield

This should be a great relief for both ASX investors and mortgage holders especially considering just last week that move to 4.48% was triggered by a worse than expected April consumer price index (CPI) print. That data showed inflation rose in April, and it pushed out the expected timing of the first RBA cash rate cut from June 2025 to October 2025.

The below graphic of the ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve shows that after the US rates move, and our own weaker than expected economic growth data yesterday – that showed the Australian economy is on the verge of a recession – the timing of the first RBA rate just has shifted back to June 2025.

ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve 5 June 2024
ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve as at market close on 5 June. Source: ASX

Note also, the timing of the second cut still eludes the look forward period. We can use the implied yield curve to work out probabilities of the second cut by a particular month though. The probability of a second 25bp RBA cut in October 2025 has improved from 10% before the recent drop in benchmark yields to 60% (it’s 72% by November).

S&P-ASX 200 Index 5 June 2024
S&P/ASX 200 (XJO) chart

The local benchmark of stocks doesn’t look anywhere near as good as the NASDAQ in terms of technicals:

  • Its short term trend is neutral, but it does sport a healthy long term uptrend.

  • Its price action is falling peaks and falling troughs, although the most recent move will print a higher trough eventually.

  • Its candles are more mixed, with only the last few since the 7601 trough qualifying as demand-side.

  • Instead of printing new record highs, there’s a clearly defined zone of historical supply above 7900 weighing on the price action

If anything, the local demand-supply environment appears to be more balanced. This means investors are far less decisive about the positive attributes of owning Aussie stocks than they are about owning US stocks.

The long term trend, punctuated by clear rallies from it, suggests there does remain steady buy the dip activity from the major fund managers. They’re not chasing prices higher.

In summary, investors in Aussie shares don’t appear to be experiencing the FOMO investors in US shares are experiencing. This could change if the S&P/ASX 200 can close at its own new record high. In that case, the next few trading sessions could be crucial.

Written By

Carl Capolingua

Content Editor

Carl has over 30-years investing experience, helping investors navigate several bull and bear markets over this time. He is a well respected markets commentator who specialises in how the global macro impacts Australian and US equities. Carl has a passion for technical analysis and has taught his unique brand of price-action trend following to thousands of Aussie investors.

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