|Summary: The local market signals are suggesting that despite strong growth in other parts of the world, the Australian economy is in a precarious position. The Australian stockmarket and dollar have both been sold heavily, while Dr Copper (a leading economic indicator) remains sick. These factors suggest more downside in the short term.|
|Key take-out: The big question for investors is when to buy in, not if. If there is another dip, there may be a better entry point to overweight Australian stocks down the track.|
|Key beneficiaries: General investors. Category: Strategy.|
It’s hard to know what to do in this environment. It’s not that I’m doubting my medium-term view. So far all the data is consistent with what appears to be my non-consensus call for a global economic acceleration over the next 12 months, followed by a lift in domestic growth here.
Consequently I think there is some decent value in the market at the moment. However, I am wondering if near-term valuations might become even more attractive. I mean, last week the fear of the moment was that the US Federal Reserve would begin a QE taper. This week there’s the China credit crunch or slowdown thematic.
Whether you think now is a good time to buy the dips, or whether you want to sell down your portfolio and go overweight cash, comes down to how much of this stuff you actually believe. Even with yesterday’s steer gain, the All Ords thus far has given up its gains for 2013 and is little changed from where it was in 2009. Elsewhere, bizarrely, there is a global bull market in equities – which Australia is continuing to miss out on.
As I’ve outlined before, I think the current consensus view that the Australian economy is going into a China-driven downturn is a very low probability event. That doesn’t mean the All Ords couldn’t fall quite hard in the interim – but with only perception driving things, it’s just so very hard to know. With that in mind, I think it’s a very valuable exercise to look at the key market signals investors are getting at this current point of inflection. Unfortunately they suggest there may be more downside yet to come. Although the upside to that is, of course, better value.
1. Markets are becoming much more optimistic on the US
2. Australia is an island and has decoupled from the world
What’s good globally isn’t good for us it seems, and through much of the rise in the S&P, DAx and FTSE100, as you can see in chart 2, Australian stocks actually sold off (through late 2011 and early 2012). The Australian market has even underperformed more recently as the Australian dollar has declined 12%, and that highlights a simple fact – the close correlation between the $A , the All Ords and the economy more broadly.
3. The market is short Australia
Noting this, it’s disturbing to see just how bearish the market is on the $A now. Take a look at chart 3. Only a handful of months ago, when the All Ords was posting solid gains, the market was very long on the Aussie dollar. Short positions have increased at an alarming rate since then, and the market is very short the $A – the most shorts in well over a decade. The other thing to note, and you can see this clearly on the chart, is the volatility on the $A. Investors and traders alike get whipsawed frequently, and the chart suggests this volatility is the greatest it’s been in over a decade.
Now, as we found out yesterday, the Reserve Bank still thinks the $A is too high. This means, and if the market consensus is correct, that more rate cuts are to come. This will only add to those short positions and the general negative sentiment toward the $A. Naturally, this is bad news for our stockmarket – not the good news that many think it is. Why? Well, we know global investors are steering clear of the Aussie market, not only because they don’t want to take exchange rate losses, but because of the exchange rate volatility itself.
Closely intertwined with that is this country’s obsession with recession. While you’ve got most of the country’s economists and strategists talking about a downturn here, it’s not exactly great to buy into our market now it is it?
Global investors know that the $A is a growth currency. Good growth means a strong $A. Weak growth means a weak $A. So if the $A is weakening and the RBA is cutting, this just reinforces the idea for global investors that Aussie earnings will disappoint – that the market isn’t that cheap. Now I don’t buy any of that, but that’s what people think, which is why I think the campaign to lower the $A is deeply misguided.
4. Copper has lost its shine
Not unrelated to this, short positions have increased sharply on copper as well (chart 4). Copper, or Dr Copper as it is often called in the market given its use as a leading economic indicator (especially for commodity sensitive countries like Australia), has been range trading like the All Ords has, for many years.
Currently at a low point in its trading range, short positions have increased sharply, which may suggest new lows, despite the lift in global economic growth and in particular US housing, which is usually bullish for copper. It’s a bad omen for our market.
So tying it all up, while I think there is considerable medium to long-term support for the Australian stockmarket, I’m not seeing too much reason for near-term bullishness. The market shot up over 2% yesterday, and given our underperformance I’d really like to see much more of that. I still think the bigger question for investors is when to buy in, not if. But the truth is the above factors suggest there is more downside in the short term. This means there may be a better entry point to overweight Australian stocks or top up on good value or what have you.