Have bulls fled or are they just having a rest?

What's gone wrong with the Australian sharemarket? Since the middle of May the benchmark ASX/S&P 200 Index has rapidly fallen by 6 per cent and now people are wondering if the bull market that kicked off on June 4 last year has finished and we are already back in a stinking bear market that has been lurking in the shadows since November 2007.

Over the past three months the local bourse has underperformed the broad S&P 500 Index by an overwhelming 12 per cent. Is it just a case of sell in May and go away or are there more than seasonal factors at play?

There are three fundamental problems afflicting the Australian market at present, all of which are temporary and will play out in the coming weeks and months. The most obvious is the departure of international money. During 2011 and most of 2012 international institutional investors steered clear of Australia because they believed the housing market was 30 per cent overvalued and about to collapse. They were also nervous about the strength of the Australian dollar.

Towards the end of 2012 a light switched on and international money started flooding into the Australian market. Investors felt more comfortable with the housing and currency issues and became obsessed with yield. Investors in Japan, US and Europe could secure only between zero and 2 per cent on their cash at home and saw yields of 6, 7 and even 8 per cent among Australia's biggest financial and industrial companies, including our big four banks and Telstra.

An avalanche of buying took place over the next six months taking foreign ownership of Australian shares 10 per cent above the long-term average. These investors did an abrupt reversal in May as the Australian dollar started to weaken against the strengthening greenback.

With the US economy gradually improving and the Federal Reserve hinting it could stop printing money, investors started to buy the greenback and sell the Aussie. Foreign equity investors packed up their tents and headed for the hills, not wanting to cop a major currency loss.

The selling by offshore funds looks set to continue in the short term. Eventually this selling will be met by local investors searching for yield as domestic interest rates fall further. This may take place soon, and we could see bank yields head over 6.5 per cent and Telstra at 6 per cent again. To date Westpac shares have fallen 17 per cent, ANZ 14 per cent, while Telstra has shown more grit in giving up just 7 per cent.

The second headwind for the Australian market has been China. Expectations of China's economy rebounding in 2013 have been dashed, as economic numbers remain disappointing. The Communist Party target of 7.5 per cent growth for the world's second largest economy looks unlikely to be achieved as the government attempts to rein in credit and the residential property boom. This is proving difficult and could take some years to fix.

Some China watchers, such as academic Professor Michael Pettis, believe China might be growing closer to 5.5 per cent than the target of 7.5 per cent.

This is a disaster for commodity prices and Australian mining companies that rely on capital expenditure in China. Our biggest export, iron ore, is the number one casualty of this dynamic as steel production slides. Iron ore producer Fortescue has seen its share price plummet by 40 per cent since February.

Such is the opaque nature of China's economic and political policies that no one has a firm grip on the situation, especially our big mining companies. The share prices of our major resource groups may bounce off oversold positions in the short term but the Chinese problems and the fundamentals are not going to improve for some time if at all.

The third and final rat among the Australian sharemarket ranks is the downturn in the domestic economy. The retail, transport and advertising sectors have all suffered a further downturn in activity since February despite the recent cut in official interest rates. Some companies are blaming it on the warm weather, others the long- dated federal election campaign. These all seem far-fetched because the residential market has some green shoots with housing finance and starts improving. Auction clearance rates for existing homes have also hit bottom and bounced in 2013.

The reality is that Australian consumers are content to pay down their debts by saving 10 per cent of their incomes and just aren't ready to spend like they did leading up to the global financial crises. Maybe they never will, but the soft domestic environment has all but ensured the Reserve Bank will deliver another official interest rate cut before the federal election in September.

A measure of how negative the domestic economy has become is reflected in the 19 per cent slump in shares of department store group David Jones, while the nation's largest transport operator Toll Holdings has fallen by 21 per cent.

With the critical housing market on the move, consumers are likely to pick up the pace of their spending in late 2013 and through 2014, which will support cyclical stocks in the market.

All of this negativity in the market should subside in the coming weeks and could create some handy buying opportunities, especially in the industrial and finance stocks. It is much harder to see a sustained bounce in the resources sector.

matthewjkidman@gmail.com