Offshore fund managers take dim view of our falling dollar

The Australian dollar this week at least momentarily broke long-term support at 93.95 US cents and the next support level is around 80 US cents if you believe the charts - although late Friday it was trading at US95.90¢.

The Australian dollar this week at least momentarily broke long-term support at 93.95 US cents and the next support level is around 80 US cents if you believe the charts - although late Friday it was trading at US95.90¢.

While we should probably celebrate the drop in the long term, in the short term it will not be good for equities. A falling currency scares off international fund managers which is why, after a 10 per cent fall in currency, the Australian equity market is down 10 per cent as well.

And in the past week something rather more ominous has started to happen. The US dollar has started to go down again, but while the euro and the British pound have hit four-month highs, the Aussie has hit a 33-month low. The US dollar is going down and the Aussie is going down more.

What is going on? Suddenly it looks like Australia, outside of the US, is developing its own rather unique set of problems, because clearly the international fund managers, some of whom could buy the whole Australian equity market on their own, are taking more than a view on the US dollar, they are taking an independently negative view of Australia and the Aussie.

We heard some of their concerns from Fidelity this week. They manage $US1.7 trillion, while the Australian stock market is capped at $1.5 trillion. Fidelity talked about the volatility of the Australian dollar being a concern that cannot be ignored, that China and the commodity sector are both "in question" and that they are re-evaluating their Australian exposure.

They might also have mentioned that federal election uncertainty has been delaying business spending decisions, that Australian GDP forecasts are in a downgrade cycle, that we are seeing persistently weaker Chinese economic numbers, that there have been a series of major industrial profit warnings and that we are experiencing a consumer holdback despite lower interest rates.

Perhaps we should be worried, not about the end of quantitative easing but that the magnetic attractions of the Australian economy as a proxy for the Asian economic miracle have peaked in the eyes of international investors. After all, the Australian resources sector actually peaked in May 2008 and is down 52 per cent since then.

See it from their point of view. The main attraction of Australia is its position as a stable, regulated investment market exposed to the Asian economic growth story. Get it right and not only do they make money on stocks, but they make money on the currency as well.

But the problem now is that, just as they have been doubly geared to success, they are now doubly geared to failure. "Double bubble" turns into "double trouble". That makes them sensitive, and understandably with that level of risk they shoot first and ask questions later.

The mere hint that the Asian economic momentum has peaked, that the Australian economy has peaked and that the Australian currency has peaked and they are understandably spooked.

So while domestic institutions concern themselves with their performance in equities compared with other domestic institutions and sit there effectively unconcerned for their bonuses and currency agnostic, the international institutions are currency sensitive and making decisions, and fast.

If Australia goes wrong they don't have to be here, and considering they hold 40 per cent of our market and their money is mobile, the risks to Australian equities are obvious.

The concern now is whether this turns into an Australian currency and equity market rout or whether we are just over extrapolating one month's performance.

For the answer our most immediate gauge (in the short term) is going to be the currency, not price-to-earnings ratios and yields, not "value" and not the buy recommendations from domestic brokers directed at domestic fund managers working on relative performance benchmarks. Get the currency right short-term and you'll get equities right short-term.

Of course, the unfortunate thing about that is that thousands of currency traders throw themselves on the rocks on a daily basis getting the currency wrong, so we have little chance. But what we can say is that we are at a point of risk, on a currency support point, and from here you can expect heightened volatility and risk. That's enough to scare a lot of investors away, at least for the moment.

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