Weekly Wrap

Market Update

Calendar Icon   Friday, 28th May 2021

ASX 200 Index (XJO)

Last week’s update alerted readers to the then weakening XJO, with a technical outlook that suggested lower prices ahead. This week, the XJO has attempted to reach the recent high of 7174, with an intra-day high of 7186. This rally has been on a lower than average volume and it would appear that the algorithms are still dominating trading.

Despite the rally this week, the outlook for the XJO is still uncertain. Optimism is still high towards equity markets, yet the price action for the tech-heavy NASDAQ suggests lower prices ahead. Caution is still recommended.

XJO Chart

East meets West

On one hand, we have an almost endless tap of monetary and fiscal policy in an attempt to reflate the global economy. On the other, tighter credit and disappearing liquidity is now the norm.

Who is going to win? The West, with its kitchen sink approach to the economy, or the East, with the Chinese hitting the brakes? This is the titanic battle being played out by central banks at the moment and the answer is dependent upon inflation. China started reining in property speculation last September and it looks like debt is the next target.

China actually tracks the ups and downs of individual financing. This is how they regulate the economy. China is credit negative right now, which is in total contrast to the rest of the world. The Peoples Bank of China (PBC) is running an orthodox monetary policy and has been vocal in expressing its desire to see lower commodity prices.

Currently, China has seen its money supply contract 3.9% in the past 6 months. In America, the Biden administration is running a budget deficit of 13.9% in a copy of the Roosevelt policy, implemented immediately after the worst of the Great Depression. The issue right now is that the American economy has capacity constraints, whereas in the 1930’s they had 30% unemployment.

The US Fed is still buying US$120bn worth of bonds each month, money supply has grown 24% in a year and inflation is running at a 25 year high.
China’s latest monetary stance is in effect contracting the economy by about 7% of GDP and its growth rates are lower than America, UK and France.

This means that the money spend in the West is at odds with China. Will commodity prices enter a new “supercycle” from China hitting the brakes? They are the biggest buyer of commodities, after all.

The West is fixated on an inflationary backdrop and the central banks are participating in this at full throttle. China is trying to stop credit growth.

What is the likely outcome?

There are a number of scenarios that will play out and the ‘Goldilocks’ outcome would see a slowing China offsetting a booming America. Eventually America will stop its spending program and the proponents of the Quantitative Easing program over the past 13 years will feel vindicated.

Or, China will change course later this year and the deleveraging cycle may cease, leading to an inflationary environment. The worst outcome would be a loss of confidence from the credit market towards American debt and the US dollar slides, leading to a worsening US deficit and interest rates climbing fast.

Financial markets would be hoping for a Goldilocks outcome.

1720 South Sea bubble is alive and well

A report from the newswires this week highlighted a few concerns surrounding the Special Purpose Acquisition Companies (SPAC) market. If you weren’t aware, the latest craze in the investing world is people putting money into a blank cheque business with no business plan, no defined outcome and a juicy 20% payoff for the promoter. The unorthodox operating procedures heavily favour insiders and put losses onto individual shareholders.

If this sounds crazy, it is no different to the South Sea bubble of the 1720’s. Back then, investors gave money to promoters in Exchange Alley London, with promises of untold riches “for a company carrying out an undertaking of great advantage, but nobody to know what it is”. Promoters were last seen scurrying down Cornhill, with investors money – never to be seen again.

Meanwhile in America, Defiance Next Gen SPAC Derived ETF, has fallen 30% since mid-February, as we can see in the chart below. Has the retail sector lost their enthusiasm? Retail trading figures have fallen significantly in the past few weeks, according to Robinhood, the favoured trading app of the new investors.

Richard Branson has been promising space flights for a few years now and with recent trials putting that firmly into play, you would expect the share price to soar. His company Virgin Galactic Holdings is 50% down for this year.

Defiance Next Gen SPAC Derived ETF