Riding the China-US market cycle

The Australian sharemarket is captive to China and the US … but timing strategies can smooth the bumps.

Summary: Like it or not, the Australian sharemarket is wedded to the economic fortunes of China and the US. But how can retail investors traverse through the volatile market conditions created by those countries? The best way is to apply a disciplined and objective market timing system.
Key take-out: One strategy is to use a diversified exchange-traded equity fund to minimise individual company risk, and to buy when the fund’s price rises above its long-term trend, moving to cash when it falls below that trend.
Key beneficiaries: General investors. Category: Shares.

The Australian sharemarket is caught between a contracting China and an expanding United States.

Our market is sentimentally attached to the New York Stock Exchange, which is why on most days the All Ordinaries index moves in the same direction as the S&P500 index. But when it comes to substance, our economy is a hostage to the fortunes of China.

Ben Graham, the father of value investing, made the astute observation that in the short run the market is a voting machine, but in the long term it’s a weighing machine. By this, he meant share prices on a daily, weekly and even monthly basis are driven by trading sentiment, but on an annual to longer basis are driven by economic fundamentals. In other words, mood matters, but ultimately reality triumphs.

As you can see in the following chart the green All Ords index is being pulled between a rising blue S&P500 stock index and a falling red Shanghai stock index.

Note how the global financial crisis of 2008 dragged all three stock indices down, while the concerted fiscal and monetary stimulus packages of 2009 saw all indices partially rebound. But after August 2009, China’s red index trended down. At first Australia’s green index kept tracking America’s blue index as the Federal Reserve went into overdrive printing money. But after August 2010 their paths diverged as Australia’s resources boom looked shaky based on China’s change of course.

China has tried to dampen its property boom by tightening credit. Also it has changed its growth model from investing in infrastructure and export industries (that are mineral and energy intensive) to promoting consumption and service industries (that have less to do with Australia).

More recent news points to a China property bust in the wake of a crackdown on its shadow banking system, closure of its less-efficient steel mills and the arrest of thousands of corrupt officials in state-owned enterprises and local government agencies that enriched themselves in cahoots with property developers. Also, China’s ruling elite now recognises that having the worst smog in the world is imperilling the nation’s health, so dirty industries must be closed.

According to official statistics China’s GDP is still growing at over 7% per annum, but it’s clear from its stock prices that Chinese investors don’t buy that story. After all, their share wealth has fallen by 40% since the Shanghai index last peaked on August 4, 2009, whereas US shareholders have enjoyed a 90% rally in the S&P500 since then. Australia’s All Ords index has risen by 25% over that period.  

The biggest challenges facing Australia now is highlighted by the following chart regularly used by Peter Harris, the chairman of the Productivity Commission, in his public speeches.

The chart shows that in the decade to 2022 the Productivity Commission expects Australia to have a dramatic slowdown in the real rate of growth of national income because the nation faces a combination of negative terms of trade (a fancy way of saying depressed commodity prices) and falling labour utilisation (as more workers become unemployed, underemployed or take early retirement).

The only way for annual economic growth to stay around 2% is to offset the negative effect of these two factors by boosting labour productivity growth from 1.3% to 2.8% a year, something that has not been achieved before.

How such a herculean lift in productivity could happen is anyone’s guess. It means a new round of micro-economic reforms sweeping through both the private and public sectors.

Deloitte Access Economics in “Positioning for Prosperity? Catching the next wave” says the ‘fantastic five’ sectors of gas, agribusiness, tourism, international education and wealth management will step into the breach, adding $250 billion to the economy over the next 20 years, thereby matching mining’s contribution. In addition, it has identified 20 other industry sectors that will also help maintain Australia’s status as one of the world’s most prosperous nations. See the full report here.

Deloitte Access Economics, "Positioning for Prosperity? Catching the next wave", March 2014

According to Deloitte five big-picture advantages give Australia a head start:

  1. World-class resources in land, minerals and energy;
  2. Proximity to the world’s fastest-growing markets in Asia;
  3. Our use of English, the world’s business language;
  4. A temperate climate;
  5. And well-understood tax and regulatory regimes.

Chris Richardson, co-author of the Deloitte study, asserts: “Our future prosperity will come from a more diversified spread of sectors, enabling Australia to remain the fastest-growing developed Western nation in the world in the coming decade.”

Let’s hope Deloitte Access Economics is right and the Productivity Commission is wrong.

What this highlights for investors is the importance of navigating the Australian sharemarket cycle. The All Ords index since 2010 has been torn between a recovering America and a restructuring China. Our sharemarket may continue rising, because the world seems to have finally escaped the GFC. But it could also crash, because resource prices that insulated us from the GFC have fallen.

The period ahead marks two possibilities for Australia: (a) we partake in a general recovery of the US and other developed economies as they shake off the last vestiges of the GFC, or (b) we become a casualty of the slowdown of the Chinese economy as it absorbs a property slump and a redirection of public spending from roads, bridges and railways to health, education and a cleaner environment.

The best way to ensure your share portfolio rides any boom, but avoids any bust, is to apply a disciplined and objective market timing system as I have discussed previously.

That involves a two-step process. Firstly, using a widely diversified exchange-traded equity fund like the SPDR S&P/ASX 200 (ASX code STW) to minimise individual company risk. Secondly, buying the fund when its price rises above its long-term trend and moving to cash when it falls below that trend.

The purpose of such trading is to smooth out the sharemarket cycle without sacrificing its good returns over time. Such trading is very slow (e.g. I’ve held my STW units since mid-2012 without one trade) since its motive is to insure against a massive loss, not gamble on making some unrealistic gain.

Sharemarket falls of up to 10% are regarded as pullbacks, 10-20% as corrections, and over 20% as crashes. Fred Isabelle of StrategicTrendTrading.com, a US market timer, nicknamed the US Federal Reserve Bank the “plunge preventer” because it seemed intent on stoking a Wall Street boom without interruption. But the Fed is now winding down the $US printing presses, so the next time the market wants to plunge it may not get in the way.


Percy Allan is a director of MarketTiming.com.au For a free three-week trial of its newsletter and trend-trading strategies for listed ETF funds, see www.markettiming.com.au.