Central banks sprang into action after the global financial crisis. They dropped interest rates and pumped the global monetary system full of liquidity to try to support activity and asset prices. The response was driven by a lack of growth. The intent is to withdraw funds and lift interest rates as economic growth recovers. In effect, these central banks borrowed growth from the future, and the “normalisation” of monetary conditions is how the debt is repaid.
Market currents at cross-purposes
Improving growth conditions (good) lead to tighter monetary policy (bad). Conversely, slowing economies (bad) mean more central bank support (good). The trade disputes are a focus for markets because of their impact on the growth outlook. A stronger GDP reading could result in shares rising or falling, depending on whether investors respond to the better data, or the potential for a central bank response.
This makes predicting market responses to news difficult and is one of the key reasons investment decisions are now complex. The market currents are flowing at cross-purposes. The response to news tells us more about sentiment than it does about fundamental factors.
Naturally, this means more weight is put on sentiment indicators, such as consumer and business confidence. Forward indicators such as factory and durable goods orders also gain in influence.
However, many investors ignore the most obvious of sentiment indicators. The price of a share, and a sharemarket index, is primary evidence. Changes in price reflect the shifting balance between buyers and sellers.
The daily chart of the Australia 200 index shows the market has traded in a range between 6400 and 6760 since May this year. Chartists and traders describe this as a sideways market, despite a few peeks outside the range over that period. One of these levels must be broken convincingly for the Australian sharemarket to begin a new trend, up or down. Until it does, the market remains sideways.
Strategic responses to current market conditions depend on individual circumstances. Long-term holders may wait for a sustained move through one of the bounds of the range. Active investors may trade the range, buying when the market is nearer 6400 and selling as the market approaches 6760. This is a price-based way for investors to doubt the extremes of sentiment in a “muddle through” environment.
The same principles apply to individual stocks. While the chart of any given stock can vary enormously from the index, investors with a good grip on the basics of technical analysis are at an advantage because of the primary evidence of sentiment they provide. There’s no need to grasp the intricacies of a five-count Elliott wave formation. Support and resistance, and trend identification, are enough to improve overall investment performance.
Michael McCarthy is chief market strategist at CMC Markets.