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Industrial Production data points to more upside for US equities

THE general equity market in the US continues to edge higher despite the ongoing trade tension. For example, the S&P 500 index is just one per cent away from the January record high of 2,872 points while the Nasdaq 100 index has recently broken another new record high in July at 7,530 points. We expect this bullish sentiment to be sustained as overall economic data continues to support the bullish narrative. For instance, consumer sentimentis at a multi-year high and unemployment rate is at a multi-year low.

One of the more interesting economic indicators that provides a reliable signal for identifying the end of the equity bull market is the Industrial Production year-on-year (y-o-y) growth rate. Industrial production measures the output of industrial establishments in mining and quarrying, manufacturing and public utilities. Production is based on the volume of the output.

Historically, once the Industrial Production y-o-y data heads into contraction, below 0 per cent, the equity market enters into a period of turmoil. This indicator acts more as a confirmation for identifying weakness in the market and economy as the top in the equity market is usually in before the Industrial Production y-o-y figure falls below 0 per cent. On average, the S&P 500 index tops out eight months before the Industrial Production y-o-y number falls into contraction.

The only exception was in March 2015 when the contraction in the Industrial Production y-o-y data failed to usher in a top. Instead, the S&P 500 index consolidated within a 250-point range for the following 15 months before a breakout higher happened. The S&P 500 index fell approximately 14 per cent off the 2017 highs, but the bearish move did not sustain. Part of the explanation for this was due to the global quantitative easing (QE) programme and zero interest rate policy (ZIRP) and negative interest rate policy (NIRP) that has been going on. It was the global effort of easy monetary policy that jolted the market higher.

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However, with the end of the QE and ZIRP era in the US, the contraction in the Industrial Production y-o-y data will be more representative when it happens as the market becomes less distorted by the Fed's easy monetary policy. The key threshold to signal the start of the bear market is when the Industrial Production y-o-y falls below 0 per cent.

Currently, the Industrial Production y-o-y data continues to portray an upbeat economy as the general trend remains on the upside. The Industrial Production has been expanding for the past 15 months, and the pace of the expansion is getting stronger, suggesting further upside in the S&P 500 index. July's number came in at 3.80 per cent, the strongest growth since 2014. Therefore, as long as the Industrial Production y-o-y growth rate continues to expand at a higher rate, expect the general equity market to enjoy further upside. The next big hurdle for the S&P 500 index will be the 3,000 psychological round number.

  • The writer is chief technical strategist, Phillip Securities Research.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice