Core Capital Goods New Orders: Expanding at a moderate pace signalling further upside in the equity market July 9, 2018 722

 This article was published in Business Times’ column “Chart Point” on 9 July 2018.
 

Source: Bloomberg, PSR

*Vertical line demarcates the point where the bearish signal is triggered

While the trade tension continues to escalate and hurt the general sentiment of the market, looking at the US economic data still shows robust growth. More notably, the 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 business. 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 Capital Goods New Orders Nondefense YoY 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 Capital Goods New Orders Nondefense YoY data falling into the contraction zone below 0. For example, after months of strong expansion in the Core Capital Goods New Orders Nondefense YoY data since June 1999, the rosy trend suddenly turned south as it hit a high of 15.4% in June 2000. After peaking out at 15.4%, the Core Capital Goods New Orders Nondefense YoY growth rate plummeted into contraction in December 2000 which exacerbated the equity market selloff. The S&P 500 index fell -41% thereafter.

A similar toppish pattern was confirmed in 2007 after the Core Capital Goods New Orders Nondefense YoY figure fell below 0% in September 2007. Prior to that, the Core Capital Goods New Orders Nondefense YoY data was accelerating at an average pace of 8% until the growth trend suddenly deteriorated. After the Core Capital Goods New Orders Nondefense YoY number fell below 0%, the implication on the S&P 500 index was a massive crash of -56% 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 0% expansion/contraction level. As long as the Core Capital Goods New Orders Nondefense YoY growth rate stays in the expansionary phase above 0%, the equity market should continue to do fine. However, if the Core Capital Goods New Orders Nondefense YoY figure falls below the 0% 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 Capital Goods New Orders Nondefense YoY data as it falls below the 0% 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 FED’s Quantitative Easing (QE) program 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 Capital Goods New Orders Nondefense YoY data to continue to provide reliable bearish signals when it falls into the contraction zone, below 0%.

The current outlook of the Core Capital Goods New Orders Nondefense YoY 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% in October 2017, the growth has slowed down to the most recent reading of 7.7%. Nonetheless, it is still expanding. Hence, the outlook remains bullish for the general equity market until the Core Capital Goods New Orders Nondefense YoY data falls into contraction below 0%.

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About the author

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Jeremy Ng
Research Analyst
Phillip Securities Research Pte Ltd

Jeremy specialises in Technical Analysis and has 10 years of experience in studying price action. His areas of expertise include intermarket analysis on the equities, currencies, commodities and bonds market.

He is also a regular columnist on The Business Times - every Monday ChartPoint column.

He graduated with a Bachelor of Science in Banking and Finance from University of London.

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