The ASX is ready for a break-out

Well, here we go again. As readers are probably already aware, the All Ordinaries Index is currently sitting at a key line of resistance.

If you don’t want to be too exact about it, it’s roughly around the high 4,000s, low 5,000s mark. Technically, we’ve just pushed through, but either way the index now sits at a five-year high.

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Confidence boosters

Now, where you think we go from here will largely depend on your view of two key indicators this week. Specifically, two key confidence indicators for the market showed a spike in confidence. So business confidence surged 9 points to be at its highest in two years (August data), while consumer confidence is at a three-year high (September data). Both great results clearly, and a boon for our economy if they hold.

Now many analysts, including those who sponsor the survey, suggest that the election and probably the change of government, or its anticipation, featured heavily in the surge. I think it was clearly a factor – confidence among Coalition voters was especially high.

However, I’m not convinced that this is the entire story. I mean, if you look over this period we’ve seen many pieces of the confidence puzzle fall into place – the Aussie stockmarket is up nearly 12% so far for the 2013-14 financial year, which compares favourably to US stocks which are up 4%. Similarly, house prices are on the rise, with many areas (especially in Sydney) recording strong price growth. Both of these factors strongly support confidence. Moreover, it’s not like the election result was a surprise or anything.

Does it matter what was driving it? Yes, absolutely. In the first instance, if the surge in confidence was simply a relief rally, or a sugar hit based on a change in government, then the euphoria may not last. Rarely has an election, by itself, led to a sustained surge or even a fall in confidence. Even the election in 2010, which saw a hung parliament, did not really bring about any meaningful change in confidence.

By far the more important influences are the global and domestic economic outlook, because regardless of who governs, if these are poor, then business and consumer confidence will remain poor.

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That being the case, we could easily go back to square one – talking about the end of the mining boom and a possible downturn over the next 12 months. Indeed that would be likely, because if confidence has surged only because of the election, then the fact is the ‘underlying problems’ of the country still exist.

Recall the dominant narrative – weak growth and as yet no replacement for the end of the mining boom. One additional problem we’ve got is that both the business and consumer confidence measures are volatile – it’s hard to tell then if one month’s spike is a signal for change.

Fortunately I don’t think the lift in confidence is solely due to the election. Think about the global and domestic economic backdrop. Without question, most of the news on this front has been positive.

• The recent run of Chinese data shows that the world’s second-largest economy is still growing at a rapid clip and that this growth is accelerating.
• US jobs growth remains above trend, jobs growth strong, and the budget deficit is sharply lower.
• Latest indicators suggest that both the European and UK economies are out of recession.
• Domestic lending, we found out this week is accelerating sharply, and auction clearance rates are high.

Why did confidence collapse?

As importantly, we have to consider what drove the collapse in business confidence in the first place. That, more than anything, will give us a guide as to why confidence is rising now. To see this. Let’s go back to chart 2. You can see that the collapse in confidence came on in earnest from mid-2011. It’s noteworthy that this was one year after the Gillard government was formed. It’s also noteworthy, because it was so sudden. The backdrop at the time was this:

• Domestic demand growth was solid and above trend.
• The unemployment rate was low at 5%.
• Global growth was accelerating and quite solid in 2011.

You may recall, however, that there were significant market concerns over Europe and also the US economies at the time. In particular, the US debt ceiling, the prospect of a US double dip, and of course the Japanese earthquake earlier, had impacted growth data quite significantly. Some indicators had slowed and seemed to justify the concern.

But those concerns over global growth – Europe and the US in particular – weren’t new. And so they can’t be the reason why confidence slumped so quickly – and we know it wasn’t politically related.

Instead, I think it was the economic debate in Australia itself that drove the slump. It was around that time that economists started talking about the need for rate cuts – that the economy then went on in 2012 to record its strongest growth in five years was no obstacle to repeated warnings about recession in this country.

This was the key difference between 2010, where despite the same global concerns, confidence remained just above average. That the Reserve Bank went on to cut rates was seen as a validation of these views and went on to intensify the sense of anxiety. Again, that growth picked up to a five-year high was not discussed by policymakers or the media – they were otherwise too absorbed by crises. 

This is all changing. While there are plenty of commentators and economists who still talk of a slowdown, their rhetoric is increasingly at odds with the global economic dataflow and key domestic indicators. While this has been the case for some years, the difference now is that there is little else to validate those concerns.

So the market is less obsessed with a European implosion or a US double dip. Similarly, the RBA has slowed the pace of easing dramatically and has signalled – at the very least – a pause. Some even suggest the next move in rates could be up. For me all of this allows a lift in confidence, and with that in mind I think what we’re witnessing is a good old-fashioned business cycle related spike. It’s less so about the election.

Macro implications

There are two reason why domestic economic growth has been slightly below trend over the last six months – and neither has to do with the end of the mining boom.

Growth is below trend, effectively because non-mining investment and housing investment are exceptionally low, and because consumer spending slowed sharply over the second half of 2012. As I’ve outlined in past pieces, there are no structural reasons why this would be the case.

On paper, both of these components should be very strong. The only reason they haven’t been is because confidence has been so appalling. It has been the only missing ingredient. With that in mind, a sustained lift in confidence should see a marked improvement in growth prospects and, of course, earnings performances for our major stocks.

This is all good, because if we can stop talking down our own country to global investors and we see earnings lift – well, then, it adds to my case – outlined in my recent piece Bull break-out – as to why the All Ords could outperform global peers over the next 12 months or so.