Technically Speaking: Investors hold to wait-and-see pattern in game of nerves

Friday 9th June 2000

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1. Dow Jones industrial average

2. Standard & Poor's 500

3. NYSE composite

4. Nasdaq composite

5. FTSE-100

6. ASX-100

Sharemarkets are starting to close in on the end of the 2000 second quarter with interest rates still a substantial concern. Central bankers seem to be playing a game of nerves with stockmarket investors. The US Federal Reserve has led the way in moving up its core interest rate settings over the past 10 months.

The Federal Reserve is not likely to be finished yet and is tipped to be moving up its federal funds rate to the 7% mark before it will be satisfied inflation is under control. Whatever the Federal Reserve does, other dollar bloc economies, such as Australia and New Zealand, will feel obliged to follow.

Evidence is emerging higher US interest rates are starting to bite. Home mortgage rates are up at high levels, the building and manufacturing industries are slowing and retail sales are easing. Oil supply is expanding with an expectation of lower crude oil prices.

From the wage-inflation view, US unemployment has ticked up from 3.9%, its lowest peacetime level since 1957, to a more manageable 4.1%, while the average wage is up by only 1USc. President Bill Clinton was quick to hail the low unemployment figures but would have known Federal Reserve chairman Alan Greenspan would have seen them as a major headache.

Mr Greenspan eased his own pain and increased that of his fellow Americans by adding half a per cent in his last federal funds hike and there will be another federal open markets committee meeting this month to see if the ratchet needs more tightening.

Share index charts shown illustrate recurrent buffeting from interest rate worries. Days when there are big falls produce news stories predicting the end of the world.

This year so far the big scare has been over April's sharp Nasdaq composite index plunge (chart 4). The news media reacted negatively to the fall but overlooked that the Nasdaq index retained some premium over its earlier average trading level of 2500 seen across much of 1999. In truth, the index held up quite well.

Investors who bought in at 2500 are still ahead on the deal.

Other indices depicted tend to show a common trading pattern of basically going sideways over the last year to date. Technical analysts term such a chart pattern "consolidation." Market psychology is the key to sharemarket trend, and a consolidation pattern shows a wait-and-see attitude from investors.

They can become unsettled when markets are up around all time highs, as many still are, while interest rates are on the rise. Jitters show up in increased volatility as indices zigzag widely around established average values or support and resistance levels. The direction of these mood swings depends on whether investors feel hopeful or fearful.

The Dow Jones industrial average (chart 1) is a case in point. It has been oscillating around 10,500 for the past year or so. At times of greater optimism or pessimism, the industrial index swings further away from the 10,500 mark than usual, but it seems to keep settling back down around that value area. When it slumps too far below 10,500, investors snap up what they take to be cheap shares and drive the index back upwards again. If it runs too far above 10,500, investors sell off their now more expensive stocks to lock in their profits, dropping the index back toward current average support.

The pattern keeps repeating and will probably continue to do so until the interest rate question resolves itself in the US economy's growth performance. Rising interest rates do not necessarily knock over sharemarkets.

Provided an economy can keep growing, and that is what Mr Greenspan is aiming for even as he tightens money supply, companies can make higher profits and increase rewards to investors. Interest rates need to threaten to rise high enough to kill off growth before most investors will dump their shares and bank the proceeds.

Baby boomers are also having an influence on sharemarket performance. It is their vast flood of savings pouring into US shares, either by direct investment or through mutual funds, that has biased the US sharemarket to rising overall in recent years.

These investors are often accumulators staying in the market for the long term and understand periods of market weakness are buying, rather than selling, opportunities to average down acquisition costs. Their investment pattern keeps shares generally firm in price.

While these people are on balance putting funds into the US sharemarket, the longer-term trend will be for the market to rise overall, with there being considerable support in times of downturn. But once these people reach retirement age and begin pulling funds out of shares and switching the money across to income investments, the reverse effect may apply, with a long bear market being triggered.

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