Markets: Winter of disconnect

Share prices are continuing to rise in the face of increasingly poor signs emitting from Australia's economic indicators.

On the train to Bondi Junction after yesterday’s S&P/ASX200 Index’s 1 per cent gain, a fund manager lamented what he sees as the disconnect between the reality of the stock market and the economy. The index is trading at levels last seen in May, closing yesterday at 5165.365. It is up 11 per cent since June 25. 

For the fund manager this is all very confusing. The economy is getting worse instead of better, he says. In July, business conditions were in their worst state since May 2009 and business confidence was at its worst level since November last year, according to a National Australia Bank survey.

In contrast to NAB’s report, stocks that have issued profit warnings or ‘tough times ahead’ are surging.

Bradken shares yesterday rose 12 per cent despite the mining products, engineering and rail provider saying it expects “lower activity levels” in the 2014 financial year. WorleyParsons rose 2.6 per cent yesterday despite expectations the mining services company will report today a lower 2013 net profit and warn revenue growth will slide.

The fund manager says many investors are now covering their short positions, causing the market to bounce. That, combined with influxes of superannuation money into shares, may be buoying the overall market.

Short covering is especially prevalent in shares associated with the resources sector, long battered by fears of a slowing Chinese economy and slumping commodity prices. Shares in the world’s biggest mining company, BHP Billiton, have gained 20 per cent since June 25. Rio Tinto is up even more during the same period, 25 per cent.

But perceptions over the Chinese economy have changed in the last week as industrial production in the world’s second-biggest economy jumped more than economists had forecast. Commodity prices are perceived to have reached their nadir by some.

Still, the fund manager warns that Australia’s economy is vulnerable as its non-mining sector has yet to show that it can shoulder the responsibility of economic growth.

The Reserve Bank of Australia obviously thinks this is the case as it is signaling another rate cut and is busy trying to talk the currency down in an effort to further kick start a moribund manufacturing sector. Consumers have yet to return to stores to spend as evidenced by the host of vacant stores in Sydney’s wealthy Paddington suburb. Recent gains in home prices threaten to swallow much of the remaining disposable income of many trying to pay off a mortgage.

The stock market will have to come back down to earth.

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