The growth rate of the Westpac-Melbourne Institute Leading Index continues to point to a solid pace of expansion heading into late 2010/ early 2011, but that pace has slowed abruptly over the last six months. The speed of the turnaround is a little disconcerting. At 10.3%, the peak growth rate in the Index back in March was extremely high and although it currently remains comfortably above its long term average a continuation of trends seen over the last few months could easily see the growth rate drop further in the near term to a below average pace. For now though, the signal from both the Leading and Coincident Indexes is still broadly positive. Both point to above trend expansion in the second half of 2010 and the first half of 2011, albeit with some tapering in the new year.
Matthew Hassan, Senior Economist, The Westpac Group, 17/11/ 2010.
The global economy always forms an important backdrop to understanding developments here in Australia. The world economy is quite divided at present. The United States, Europe and Japan are struggling to recover from the effects of the financial crisis, while emerging Asian economies, and to a lesser extent Latin America are growing strongly…….. Overall, the outcome for global economic growth over the past year has been strong. When the figures for 2010 come in, they are likely to show that the world economy grew by about 4.75%, a rate that is noticeably above trend. Most forecasters are expecting that growth of the global economy over the next couple of years will be slower than in 2010, though probably at a pace that is close to trend…….. The US economy clearly lost momentum around the middle of the year, with GDP growth slowing to an annual rate of 2 per cent over the June and September quarters. This is below potential. Our reading of the recent data is that they have been a bit stronger, but nonetheless consumer confidence remains low, the housing and labour markets remain weak, and the repair of household balance sheets still has quite a way to run. Basically, the US household sector is in very poor shape. One of the features of the US economy that has changed over the past 50 years or so is that households are now bearing more of the brunt of recessions than used to be the case, and business is bearing less. After each downturn it has taken progressively longer for employment to regain its peak…….. The US corporate sector is in pretty good shape.
Ric Battellino, Deputy Governor, Reserve Bank of Australia, Perth 18/11/ 2010.
Most people view contemporary economics like the hypothetical jigsaw puzzle – tedious and unrewarding – and economists as eccentrics looking for a solution to an unendurably complex puzzle. But it can be a financially fatal error to shrug off economics as pointless if you want to make money in the financial markets. It is the designs of theoretical economists and the alleged solutions to economic problems instituted by bureaucrats and congressmen that largely determine the long-term course of business activity and the direction of price movements.
Victor Sperandeo, "Trader Vic – Methods of a Wall Street Master", 1991.
TRANSITION
The recent speech by Ric Battellino is well worth reading in its entirety as it indicates (to us at least) that the world is still transitioning towards trend growth (less assisted by abnormal stimulus/ bail-out measures), and it cannot get there unless, and until, America and Europe joins the recovery with enhanced momentum from their current positions. Australia is well placed in Asia and our two main exports – coal and iron ore are showing both price and volume growth. A new long-term (say 3-5 years) bull-market begins when the fundamental economic and corporate underpinnings are consonant (in harmony with) a confirmed support level in the major indexes. Ecinya does not believe that we are quite there as yet, and volatility will stay in evidence and confidence will ebb and flow. This means plenty of opportunity for the nimble, but obviously with an increased level of risk.
The nexus between the economy and the stock-market is not linear. Liquidity and confidence are also important drivers, particularly when the economic outlook is uncertain. Best gains are made when things are so-oversold, when the ‘crisis’ word is being shouted from the parliamentary roof tops and featuring in public discourse (buy in gloom), or when markets are reaching a level of euphoria that is unsustainable and/ or being expressed as a new age of prosperity (sell in boom). The Ecinya Market Barometer (clik to link) is a useful reference tool here.
THE CHARTS ABOVE
The first chart compares changes in the SP500 and the All Ordinaries index (XAO) with changes in world gross domestic product (GDP). GDP is the market value of all goods and services produced in an economy including exports and after deducting imports. We have smoothed the data by using a 3 year year moving average to make the correlation work better and to mitigate the wild percentage swings generated by annual movements. Generally the chart shows the following –
- When the world is growing markets are going up at a strong pace as listed companies are such a large part of the business landscape. When the curve flattens be careful, as the downturns tend to be sharp and deep.
- The SP500 series has a better fit than does the XAO. Given that the US is about half of total world market capitalisation this is not surprising.
- Markets tend to lead the economies.
- Markets over-shoot on both the upside and downside.
- Australia lagged until about 2001 and then outperformed as our commodities were eagerly sought by Asia.
- The impact of the 2007-2008 global financial crisis can be clearly seen.
- The tech-telco crash of 1999- 2001 can be clearly seen followed by the Greenspan era of easy money as the Iraq war got into full swing.
When markets are up look for reasons why they might go down. When markets are down look for reasons why they might go up. Be prepared to move as soon as you are convinced that the market has started to agree with your conclusions.
The XAO vs Domestic GDP chart uses annual data and has not been averaged over any period. The fit seems particularly good to us and our market seems to lead the economy fairly well. This conclusion appears to be supported by the Westpac Leading Index conclusions summarised above and which are available on the Westpac web-site in their entirety. Westpac are saying that there are signs of a slow-down. This accords with our own observations and is reflected in our company models where growth forecasts are less than robust without being significantly negative, except perhaps for parts of the retail sector. Australia’s central bankers have raised interest rates somewhat pre-emptively in our view. Our guess is that they are disturbed with current spending levels, particularly by the federal government. In a beautiful world for stockmarket bourses the combination of lower interest rates and lower taxes tends to accelerate corporate earnings and consumer confidence with greater momentum than does fiscal stimulus which often leads to waste and unintended consequences such as inflation.
SO WHAT DOES THIS MEAN IN CURRENT LOCAL STOCK-MARKET TERMS ?
- The macro environment is recovering, but there are fragile elements with the USA being the worst of the economic performers on a weighted-for-importance basis.
- Stock-picking is essential.
- Dividend are important and look carefully at companies that are maintaining or increasing dividends to determine that it results from operational confidence, not protection of the share price.
- For the longer-term investor ‘accumulate’ is currently a better strategy than ‘buy and hold’. The banks seem obvious candidates for accumulation but watch entry points.
- Special situations are important, many stocks are in recovery mode having re-capitalised, paid down debt, restructured etc.
- Takeovers are marvellous opportunities.
- Selling into over-bought strength to keep cash on hand is important. We call this active value management.
- If you are speculating make certain you do not believe you are an ‘investor’. Many of the 52 week highs are indicating that ‘penny-dreadfuls’ are in strong demand.
- Watch the economy.
- Watch technicals. Use tools that show direction and trend. Try to identify turning points. Moving average cross-overs are useful tools on both the buy and sell side. The most important thing after price is volume.
- Watch overseas markets – in particular the SP500 and the Shanghai indexes.
- Stay in touch with the China-India story.
- THINK, ACT, REVIEW….. on a regular basis.