Australia, You Have Problems…

One of the things I love about markets is that they never follow a script. Anticipating a correction as the year got underway was a pretty standard call. Even I made it.

I mean, it had been two years without so much as a stock market blip. So saying that 2018 would come with greater volatility was hardly going out on a limb. You’d be dumb to think otherwise.

But who thought we would get a two-day move like the one we just saw?

It was like the market said, ‘You want a correction? Get this into ya!’

Check out the plunge in the ASX 200 in the chart below. While I thought the US market was due for a decent correction, I assumed the Aussie market would hold up much better, given that it didn’t rally anywhere near as much. As it turned out, it held up only slightly better…which wasn’t much consolation yesterday.

The plunge in the ASX 200 - S&P 07-02-2018

Source: Optuma
[Click to enlarge]

The market plunged 3.2%, and took prices back to where they were in October 2017.

From a technical or charting viewpoint, this is a firm rejection of the 6,000 point level. To see what a I mean by that, take a look at a longer term chart of the ASX 200:

From a technical or charting viewpoint, this is a firm rejection of the 6,000 point level. 07-02-2018

Source: Optuma
[Click to enlarge]

The Aussie market peaked at 6,000 points in March 2015, before going into a sharp and relatively short bear market. From peak to trough (January 2016) prices fell 21.5%.

Then the global recovery got underway and the market rallied. But we lagged most other global stock markets. The index did push through the 6,000 barrier late last year, but it wasn’t convincing.

While stock markets around the world surged higher on a daily basis, our market really struggled. Now, with a global correction kicking in, the Aussie market has dropped sharply below what should have been a decent support level.

Before I explain why that might be the case, and why the Aussie market is increasingly becoming a backwater, just one comment on the ‘technicals’.

I know a lot of people think trying to read the charts is nonsense. I’ve had comments before that ‘6,000 is just a number, it can’t possibly mean anything’.

Yes, 6,000 points is just a number. I’m not suggesting people consciously sell or buy just based on a round number. The important thing to understand is what 6,000 points represents.

That is, it represents a combination of 200 different stock prices, all moving based on their individual influences and industry dynamics. Combining all this into one price is very information rich.

Of course, the information it dispenses is subjective. That’s why you need to have a good understanding of the fundamental factors influencing stocks and the economy to make an accurate — or hopefully accurate — interpretation of events.

And based on my interpretation, yesterday’s sharp fall below support at 6,000 points (and back to where we were three or 10 years ago) suggests a certain malaise in our economy.

Let me explain… 

Unease in the Aussie market

Firstly, the political situation in this country is a disgrace. It has been for years. Nothing gets done, there is no planning, no foresight. The political imperative in this country is to stay in power by becoming as small a target as possible…and to bicker and jab at your opponents.

The Aussie economy is built on high house prices, and the political system is all about keeping that going. Keep interest rates low, keep population growth high. It all feeds into higher house prices, which keeps the population ‘rich’ and dumb.

Maybe we just get what we deserve…

Because of this long-running policy, we have little stock market diversity. The market is heavily weighted towards financials, property trusts and other interest rate sensitive stocks. This is all the result of the financialisation of the economy.

The next biggest sector is resources. Its performance is dependent on China and global economic conditions. It has nothing to do with Australia’s political direction or influences.

Because global growth has been strong over the past few years, it’s been good for the resources sector, which brings income into the country and allows other sectors to flourish.

But this strong growth means our interest rate dependent sectors are struggling. The Reserve Bank hasn’t cut rates since mid-2016, and the housing market is feeling it. House prices have plateaued. That means credit growth for the banks is weak.

At the same time, strong global growth means bond yields (market based interest rates) are on the rise, which again is not good for our banks as it increases their borrowing costs.

It’s not good for yield sensitive stocks like infrastructure funds and property trusts, either.

In short, Australia’s market is horribly dependent on easy money and low interest rates.

How to escape this lack of diversity?

Invest in resources, or focus on picking stocks outside of the interest rate sensitive sectors.

And go global. Look to diversify with international stocks.

Another problem with Australian based companies is that they find it very difficult to expand offshore, which limits the growth of the large-caps. Operating in a cosy duopoly-like industry structure doesn’t lend itself to offshore expansion.

Wesfarmers [ASX:WES] is the latest company to succumb. It’s struggling to replicate the Bunnings model in the UK and Ireland, and just wrote off $1 billion on this expansion.

Maybe it will eventually work. But I’m not holding my breath.

Yesterday’s plunge in stock prices tells you Australia has deep seated problems that go well beyond a one-day stock market panic.

Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

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