Equity outlook positive as US capital goods data still expanding

WHILE the trade tension continues to escalate and hurt the general sentiment of the market, US economic data still shows robust growth. More notably, consumer sentiment, ISM manufacturing PMI, retail sales and unemployment rates are at their multi-year extremes.

For this article, we will be focusing on the Capital Goods New Orders Nondefense Excluding Aircraft and Parts data (Core) to gauge the health of the economy and how it affects the equity market. It gives us a clearer view of capital spending done by companies to further expand their businesses. Some examples of the orders are: construction machinery, electronic computers, medical materials, heavy duty trucks and office furniture. A rising purchase order signals a growing economy as companies spend more on expansion.

Our study showed a strong positive correlation between the Core year-on-year (y-o-y) data to the S&P 500 index since 1998, but the correlation broke in May 2010. More importantly, notice how the dot-com bubble peak and the Global Financial Crisis peak were both confirmed by the Core y-o-y data falling into the contraction zone below zero.

For example, after months of strong expansion in the Core y-o-y data since June 1999, the rosy trend suddenly turned south as it hit a high of 15.4 per cent in June 2000. After peaking out at 15.4 per cent, the Core y-o-y growth rate plummeted into contraction in December 2000, which exacerbated the equity market selloff. The S&P 500 index fell 41 per cent thereafter.

A similar toppish pattern was confirmed in 2007 after the Core y-o-y figure fell below zero per cent in September 2007. Prior to that, the Core y-o-y data was accelerating at an average pace of 8 per cent until the growth trend suddenly deteriorated.

After the Core y-o-y number fell below zero per cent, the implication on the S&P 500 index was a massive crash of 56 per cent over the following 16 months.

Hence, we can conclude that the key threshold to watch for the beginning for an equity bear market is the zero per cent expansion/contraction level. As long as the Core y-o-y growth rate stays in the expansionary phase above zero per cent, the equity market should continue to do fine.

However, if the Core y-o-y figure falls below the zero per cent line into contraction after months of strong growth, that will be the confirmation of a bear market.

Note that there was a big discrepancy in the bearish signalling of the Core y-o-y data as it falls below the 0 per cent level since August 2012 shown by the yellow highlighted box in the chart. Instead of seeing a fallout in the equity market, the bull market raged on.

Part of the reason for this raging bull market despite the weak data was because of the US Fed's Quantitative Easing (QE) programme and zero interest rate policy (ZIRP) that provided the extra tailwinds and liquidly to the market.

However, the era of QE and ZIRP have already ended in the US, and we expect the Core y-o-y data to continue to provide reliable bearish signals when it falls into the contraction zone - below zero per cent.

The current outlook of the Core y-o-y data is still in the expansionary phase, but the speed at which it is growing is slowing.

Since hitting a growth rate of 12.9 per cent in October 2017, it has slowed down to the most recent reading of 7.7 per cent.

Nonetheless, it is still expanding. Hence, the outlook remains bullish for the general equity market until the Core y-o-y data falls into contraction below zero per cent.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice For further reference, go to stocksBnB.com