The Only Way the ASX 200 will Sustain a Break Above 5400

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Maybe it will happen today…but I doubt it.

The ASX 200 breaking through 5400 points, that is.

As I’ve pointed out previously in The Daily Reckoning, this is an important level for the index. If it sustains a break through here for more than a few days then it’s telling you the market is headed higher.

Have a look at the chart below to see what I mean. It shows the ASX 200. The green line represents the 5400-point level. Back in 2015, this was a level of support for the market. But then it dropped through there sharply in August 2015.

It rallied back to near 5400 in October 2015 before turning back down again.

But now the ASX 200 is back knocking on the door of 5400 points. As a general rule, former support levels turn into resistance…until they are breached. And when they are breached it is generally a bullish sign.

Source: Market Analyst
[click to open in new window]

But, as you can see in the chart, this resistance level is again proving formidable. Yesterday, the market just couldn’t cut through it. That was despite a strong lead from overseas markets and an oil price approaching US$50 a barrel.

Overnight, the ASX 200 futures market closed up six points at…5399 points.

Given the large index weighting towards the banks, you really need to see this sector rally to give the market another leg up.

But it’s looking increasingly unlikely. As today’s Australian reports, despite the appearance of attractive dividends, there are plenty of headwinds facing the banks:

In the wake of soft interim results and the fragile property market, brokers are resetting their views on the big banks owned by millions of Australians. Even juicy dividend yields can’t tempt some.

Brian Johnson, CLSA’s seasoned banking analyst, yesterday released an almost 300-page report to clients telling them to remain underweight the big four lenders, citing settlement risks on apartments, dividend cuts and a $33 billion capital hole that would need to be filled.

Johnson is probably the best bank analyst in Australia. He knows the industry inside out. In contrast, some believe the banks are buys, given their healthy dividends and the likelihood of the RBA continuing to cut rates.

Buying a stock purely for the dividend yield is a poor strategy. Stocks that trade on high yields often do so because the market doesn’t think the yield is sustainable. The Big Four banks trade on an average yield of just over 6%, which is highly attractive…perhaps a little too attractive.

Whether the banks can maintain profitability (and therefore dividends) in the face of a weak economy, rising bad debts, and the likelihood of more capital raisings, remains to be seen.

Let’s make it easy though…and perhaps a tad simplistic. If the index sustains a break above 5400 points, I’ll assume it will come from strength in the banks. That means the market thinks the dividends are intact for now.

I’m with Brian Johnson though. I can’t see how the banks rally strongly from here. But I’ll change my view if the market tells me I’m wrong.

Don’t underestimate the power of low interest rates. It may stave off an increase in the bad debt cycle, keeping the economy limping along for another six months or so…and keep investor capital flowing towards the banks.

But then there’s the pesky issue of a spluttering economy. The iron ore price is now back below US$50/tonne, draining income from the economy once again.

Capital investment data out yesterday showed that the unwinding of the mining boom continues to be a drag on the economy. In the 12 months to 31 March, capital expenditure fell 15.4%.

The only bit of good news from yesterday’s release was that spending plans for next financial year aren’t as bad as initially thought.

Based on the second estimate of capital expenditure for FY17, total investment spending will fall 14.6%, instead of the 19.5% as indicated in the initial estimate.

Still, it’s not enough to satisfy the government’s rainbow and lollipop laced budget estimates. In a clear sign that national budgets are nothing more than a PR campaign, the government forecasts business investment to fall by just 5% next year.

Given we’re clearly over the peak of dwelling investment (which to a large extent softened the blow of falling mining investment over the past few years), just where the additional investment spending will come from is anyone’s guess.

When this reality becomes apparent, the government of the day will realise that they must increase investment spending themselves. It will still take a while for this trend to unfold, but you’re going to see more infrastructure spending announced in the years ahead.

There is of course the little problem of the government’s AAA credit rating to maintain. Both parties have pledged to keep this important rating, so throwing extra billions around in politically sensitive electorates might prove difficult in the short term.

But the extraordinarily expensive and wasteful NBN project managed to stay off the budget books because of its ‘commercial’ nature. So don’t be surprised to see more ‘commercial’ infrastructure projects get the go ahead in the years to come.

The bottom line is that, even if consumer spending keeps growing at its current modest pace, falling investment spending risks slowing the economy.

That’s why you’re likely to see more interest rate cuts by the end of the year. It’s a vain hope that the final cut will be able to produce something that umpteen cuts before it haven’t…sustainable growth.

Given current orthodox economic thinking, it’s a hope that will prove vain indeed.


Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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