The recent strong run in the Australian share market has all but removed the post GFC fear from most investor’s minds. Australia is experiencing good economic growth for reasons far broader than those driving up the US market – printing money is driving the US economy, while at home, we are benefitting from resurging demand for commodities, and a growing population. Recent reports show that our population growth will be the second largest in the world over the next 30 years. This will underpin our economic growth for decades to come. All of this is good news for our economy, but doesn’t guarantee that our sharemarket will be impervious to ongoing bouts of volatility and the possibility of (perhaps severe) market falls.
The RBA has recognized that inflation is rising and has started the process of tightening of monetary policy, with a 0.25% rate rise at its last meeting. Further rate rises are expected, as inflation continues to come back into our system. As David Murray said at this year’s ASIC Spring School, “the question isn’t whether we will recover from the GFC (he was right), the question is how good will the quality of the recovery be”. What he was referring to is the need to ensure that massive injections of liquidity need carefully to be withdrawn over time – to ensure that we don’t create another asset price bubble, fuelled by cheap money.
The “Hot Money” is taking profits, now
It’s likely that a large part of the recent Australian sharemarket growth has, in fact, been fuelled by “hot money.” By hot money we mean money that flows into the market in search for opportunistic returns, often based on short term trading rather than long term investment. The rapid rise in the Australian dollar against most other currencies reflects, in good part, the reality that foreign investment is coming into our share and bond markets, as foreign investors take advantage of the strength of those assets and their capacity to generate short term returns. When foreigners invest in our sharemarket, they have to buy A$ to do so, and that drives the price of our currency up.
When better opportunity for returns appear elsewhere, this money moves to that next opportunity – often triggering the market to fall as it exits. When we see that turnover and volumes on the ASX are at relatively small levels compared to pre GFC, we can see that longer term institutional money is yet to come back into the Australian market in as pronounced a way as it was pre GFC. This means that we need to be very careful about, and prepared for, our sharemarket to move down as well as up for the foreseeable future. Our market fell by over 6% in the last two weeks of October – and this shows how volatility can still be seen at work in our market. Further falls in the first week of November tell us that we may see the market fall by up to 15% before its returns to positive territory.
The good news is that the inflow of foreign money to Australia reflects the fundamental strength of our economy – a theme that we have been emphasizing for all of this year. We can see no better a statement regarding this than in Saul Eslake’s column in The Age on 29 October 2009:
“…strong demand from China and, to a lesser extent, India, for the mineral and energy resources with which Australia has been richly endowed will exert a substantial influence over the pattern of economic growth in this country over at least the next two decades. The likely expansion of the Australian resources sector will boost the overall level of productivity and returns to investment in the Australian economy, attracting additional foreign capital and underpinning a stronger Australian dollar in much the same way that the ‘IT revolution’ attracted foreign capital to the United States and boosted the value of the US dollar during the second half of the 1990s.”
So, over the next few years the Australian economy and sharemarket will be at the forefront of world growth. But at the same time, investors need to be very careful about the likelihood of more short term volatility, and to position their investment portfolio to have a defensive bias, at the same time as exposure to quality assets for long term growth.
But what “hard” data is driving the current market correction?
Alpha works with Alan Kohler’s Eureka Report, and one thing for sure – Alan has the ear of many influential decision makers in Corporate Australia. So it’s important to take account of what Alan has been hearing from chairmen like Maurice Newman (ex CEO of ASX and now chair of the ABC), who is reported in the weekend Eureka Report as reminding us how much of the current rally has been driven by Governmental stimulus:
“The global economy is still in intensive care and could suffer a relapse at any time. Stock market investors who feel they have been left behind should ponder this and ask whether the recent strong market action is the real thing, or a rally in a secular bear market. Because, while the green shoots may be enjoying the warm breeze of stimulus now, the time will come when that breeze becomes the cold wind of fiscal repair.”
We agree with those sentiments in general as they apply to most developed nations, especially the likes of the US, UK, Europe and Japan. So we need to be mindful that the cash supply that is washing through our market has provided an unusual stimulus, which in the case of most of those nations, doesn’t disguise that they are in the so-called “secular bear market” – (ie, over the long term, despite the occasional strong rally, overall these markets are in an extended bear phase).
As we noted above, the savior for Australia lies in the ground - and its counterpart is the demand for these commodities from China and Asia. In a landmark presentation to the recent Citibank Australian Investor Conference, RBA Deputy Governor Philip Lowe noted that China’s internal demand has remained strong during the GFC and that this has helped Australia weather the global storm. Have a look at the graph below which shows how our exports (including merchandise) are being re-oriented towards China:
That’s why Lowe was so confident in stating that:
In the current global downturn, we have benefited from this re-orientation of our exports towards Asia. Despite global trade falling by nearly 20 per cent over the past year, the volume of Australian exports stayed broadly flat over this period. The strong recovery in China saw demand for raw materials rebound strongly, and Australian producers were able to respond quickly. (In “The Growth of Asia and Some Implications for Australia” October 2009, at p.19)
Click HERE to view this report.
Against the backdrop of uncertainty in many of the largest global markets, but noting that the conditions in Australia are far more benign (as they are in much of Asia), Kohler concludes his analysis of the reasons why our market has fallen recently by quoting from the doyen of investors, Benjamin Graham:
“Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble...to give way to hope, fear and greed.”
Alpha continues to expand our range of investments suitable for these market conditions, and to provide our clients with robust investment solutions to reduce risk at the same time as providing a platform for strong returns.
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