How long can the equity rout continue?

There are several reasons why Australian stocks look set to turn around and follow the local currency higher.

Over the last thirty days of trading, the All Ords has pushed higher on only 10 sessions and has posted the worst performance since mid-last year -- down around 9 per cent so far.  Now while few would seriously suggest that the equity bull-run is over, there are legitimate questions over just how long this correction will last -- and whether it’ll extend into deep territory.  I think the winds of change may already be blowing, although I’ll confess up front that it’s hard to be completely sure at this stage. There have been some seemingly bizarre and random price moves of late and the pull-back itself was without cause. But, I think there are four good reasons why a rebound is due soon.

First up, following the nearly 9 per cent decline on our stock market since a peak only a month ago, Aussie shares are cheap. Make that dirt cheap for foreign investors, given the currency has slumped in tandem.  In that regard it’s noteworthy that we are seeing both the Aussie dollar and the All Ord’s hit some key support levels.  Usually you would need to see something quite significant -- not just a turn in sentiment -- to see those break. We can’t table thump here, from a fundamental perspective recent price moves, across a broad range of asset classes, has been nothing short of bizarre and markets can detach from fundamentals for a considerable period.  

Yet clearly some of the wind has been taken out of the bearish sails. In particular, have a think about those Chinese trade figures we saw yesterday. They’re important as they show that China is managing to slow credit growth to the property sector without too much disturbance to the broader economy.  Year in and year out we’ve had forecasts for the Chinese hard-landing and that call still looks as elusive as ever.  The fact is, the underlying China story remains a little more mundane: The Chinese government wants slower more manageable growth. It’s one thing for a $3-4 trillion economy to grow at double digit rates between 10 and 12 per cent, it’s quite another for a $10 trillion economy to do the same.  This is why the Chinese authorities don’t want to unleash, what could be, quite considerable stimulus. That they’re not, as one of the few remaining large economies in a position to do so, is telling. They simply don’t see the need. The domestic economy otherwise is growing at a strong pace and export growth suggests demand for Chinese products has picked up sharply.  Yesterday’s sharp rise in exports was the third consecutive strong print.

That brings me to my third point. A lot has been made of the recent IMF decision to downgrade global growth forecasts.  In a way it seems that many have mistaken those downgrades as a forecast for a downturn. Fact is though, the IMF is still forecasting stronger growth over the next 12 months -- that is, growth is expected to accelerate not decelerate -- notwithstanding concerns over Europe.   The downgrades themselves were modest and got more press than they deserved: Negligible really and little different from statistical noise. It’s certainly irrelevant to the market.  

As a final point, the greenback is looking toppy, and may have already turned. It’s had a hard run for a few months now, driven by expectations for a near-term hike from the Fed.  I described why that was unlikely a few weeks ago, (Markets should brace for a wild ride, September 19).

However, the rapid change in Fed rhetoric has surprised me -- I had thought they’d wait until later in the year. Either way, it takes out much of the support for the USD which is already trading close to a strong level of resistance. If that’s the case, we may also see commodity prices push higher -- a boon for our market.

The Australian dollar could be a key indicator in that regard. Indeed, the local currency and our equities often enjoy a positive correlation which makes sense. That is, what’s good for our currency is good for our stock market as well -- and both generally move up or down in tandem. At this stage, only the Australian dolllar looks to have reacted to the better-than-expected Chinese data flow, but if I’m right, then this current equity market rout won’t last too much longer -- especially with nothing in the way of fundamental drivers behind it. We’ll see what comes out of the US earnings season, and, of course, war and pestilence can obviously change everything -- but in the absence of those, the market is well positioned for a rebound. 

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