Bull break-out
Summary: The Australian market has been range trading since the GFC, but there are six key reasons why it could be about to break out and join the global bulls. They include a changing global policy mix, the Reserve Bank’s neutral course, improving conditions in China, and stronger conditions for commodities. |
Key take-out: The main roadblock to a break-out would be a new Asian financial crisis, or a crisis somewhere in the emerging markets. Australia, like other markets, would not be immune from this. |
Key beneficiaries: General investors. Category: Shares. |
Market’s seem to be at one of those bizarre points where you can almost sense that some change is in the air.
The taper is the talk of the town (that is, less printing of money) and global equities are off a bit, although whether that turns into a full-blown correction remains to be seen. That the Australian market has underperformed so far is well known, although the reasons offered for that underperformance vary and are not uniformly agreed upon. Now I can’t say for certain that the range trading that has gripped our market since 2009 is over; confidence is a funny beast and extremely difficult to pick. I mean, who knows what the next bout of fear will yield?
Noting that risk though, I am seeing some key market signals which suggest that maybe, finally, we could see the Aussie market break out of its range and join the global bull market.
Changing global policy mix
When you think about what is preoccupying markets at the moment it’s all about when the Fed may taper its quantitative easing program. This is obviously critical, because while investors may disagree about magnitude, I don’t think anyone really refutes the fact that QE has given US stocks a boost – even if just through sentiment, the Bernanke put etc. Taking that away, or reducing it, is viewed, rightly or wrong (wrongly I believe) as a tightening in monetary policy and something that will therefore weigh on stocks. Regardless of the theory, while that discussion plays out and the tapering is conducted, over many months, investors may be tempted to look for easier pickings. No one really wants to invest around an academic discussion on whether the Fed’s actions represent a tightening or not. The only thing investors are going to register is that QE boosted stocks (to whatever degree) and now that is ending. There is a growing likelihood that the US may be put in the too hard basket for a while – and investors may flock to easier pickings.
Developed world markets have had a hard run – too hard?
The above point is especially likely given that US markets, and indeed those in Europe as well, have had such a hard run. Investors may not agree as to whether, or to what degree, valuations are stretched, but there’s not much resistance to the idea that after such strong gains, some caution is warranted. So consider that even with this latest 3% sell-off, the S&P500 is still up 16% so far this year and 47% above its 2009 peak. The German Dax, meanwhile, is up about 10% and 40% above the 2009 peak. Talk now is of a correction and, while that may or may not come, you can bet that the mere talk of it has investors looking for other alternatives.
On the domestic front, the RBA is set for a market neutral course – this will boost confidence.
Against that global backdrop, there is strong likelihood that the Reserve Bank will be on hold for some time. They’re certainly not going to tighten anytime soon, and the easing cycle appears to be coming to an end. This should lift business confidence, consumer confidence and encourage global investors back into the market. Recall that a key deadweight on confidence in Australia has been the policy reaction function. Australia went from a strong economy in 2012, driven by solid consumer spending and mining investment, to one where a sharp deterioration in confidence, spurred on by panic among our policymakers, saw consumer spending fall sharply – even in the first quarter of 2013. A more neutral approach by the RBA – a steady hand – will change the economic discussion in Australia and perceptions. I suspect the perception will be that if they’re not cutting, things can’t be getting any worse – and if they’re not getting any worse, they must be about to get better.
The China hard landing story is fading
The periodic bout of China blues is waning once again – iron ore prices are sitting around the $140 mark, Chinese investment is still surging with growth rates around 20%, and industrial production growth rates are just below 10%. Bears haven’t quite given up but it seems that for another year at least, the worst hasn’t occurred and talk of it is dying down – another sentiment boosting tick for the Aussie market.
Sentiment toward commodities is lifting
Indeed in the metals space there is plenty of talk about another boom for copper, silver or even gold. Maybe it’s that China isn’t having a hard landing, maybe it’s the fact that commodities generally have been oversold or some combination of those and other factors – e.g. the supply ‘surge’ doesn’t seem to have amounted to much . Whatever the case, market sentiment does appear to be changing – spot iron ore for instance is at $140 in contrast to expectations of $100 or below. Now prices may come off like they did in September last year. But if there is one thing we’ve learned since then it’s that those price swings reflect seasonal variations – temporary factors etc. Not a structural decline due to a collapse in steel production or anything. Against that backdrop our miners are very cheap! Far too much fear, consistently unrealised I might add, is factored into the market and even with the latest 20% gain on both Rio and BHP, they are still cheap. Now don’t forget that resources are about 20% of our market – so if the China hard landing story is fading and commodities are pushing higher, that’s a significant boon to our overall market – as is point 6.
The housing market is turning
Auction clearance rates are high – back to records in Sydney – lending growth is picking up, and house prices are on the march. This should support our banks. At 25% of the market, that’s another major boost to the overall market. On current earnings projections, our banks don’t necessarily look cheap, but then again, those earnings assumptions could be very conservative if the housing market is set to rebound – and the planets are indeed aligned for a very strong rebound here. Record auction clearance rates in Sydney suggest it’s already happening.
A new Asian crisis?
It’s early days on this one but there has been chatter about a new Asian financial crisis developing – or some crisis somewhere in the emerging markets. India seems to be getting the bulk of the news, but concerns have also been raised on Indonesia and other economies. If this idea gets traction I’ll write more about it in coming weeks. Let’s see where it goes, but at this point I would just watch and wait. Certainly emerging markets are a medium-term buy, as I’ve discussed. But as we know, if the market latches onto something and runs with it, the market moves can be wild. I doubt Australia’s stockmarket could avoid the fallout in that instance. Watch and wait.
Conclusion
With all of that in mind, I can appreciate that Aussie stocks aren’t going to spurt higher over the next couple of weeks if there is a global equity correction based on QE tapering fears or an ‘emerge-ageddon’ (can I claim that one as mine?) Maybe too early. But any correction based on that is going to be very short-lived – less so perhaps than a new emerging market crisis. So it’s worthwhile thinking about what market sentiment might be like after. With that in mind, these six signals suggest the Aussie market could finally outperform global peers, subject to emerging events.