This Is Why the Aussie Market Soared

While global stock markets got something of the shakes last week…especially emerging markets, Aussie stocks powered ahead. Given the escalating trade war tensions between the US and China, it’s surprising we emerged unscathed.

What’s going on?

I think it’s a combination of a few things. Firstly, economic growth in Australia is pretty solid. At least it was in the first quarter of the year. Nominal growth (measured in current dollars, which is important for the stock market) came in at 2.2% in the March quarter, a remarkable 8.8% annualised.

While such a strong growth rate isn’t sustainable, it’s still a boost for company profits and stock prices. And while growth surged along at this pace, official interest rates remained glued at a 1.5%!

 

The secret behind the growth of Aussie stocks

The thing is, at the time this growth occurred, or even before it, the Aussie market didn’t get too carried away. Global markets endured a sharp correction at the start of the year, and Aussie stocks got caught up with that.

But over the past week or so, a few things happened to ignite local prices.

First, the Aussie dollar tanked. In recent weeks it has declined by nearly three US cents, to fall below 74 US cents. Since the start of the year, when it traded at a high of 81 US cents, it’s fallen more than 8%.

A falling dollar adds stimulus to the economy. It’s like an interest rate cut, but works on different parts of the economy.

 

 

The more recent decline in the dollar is probably due to the RBA becoming less hawkish on interest rate hikes. For some time now, the RBA has conditioned the market to expect the next move in rates to be up.

But, as the Financial Review reported last week, that view may have changed:

The Reserve Bank of Australia has omitted a crucial piece of language in the minutes of its last meeting, issued on Tuesday, leaving economists questioning whether the central bank has become more dovish on interest rates.

After its meetings in April and May, the Reserve Bank concluded: “In the current circumstances, members agreed that it was more likely that the next move in the cash rate would be up, rather than down.”

In the minutes of the June meeting, the Reserve Bank makes no reference to that line. The Reserve Bank left rates on hold at 1.5 per cent.

And didn’t the banks love it!

Have a look at the chart below. It shows the ASX 200 Financials index, which is dominated by the banks. In six trading sessions, the index jumped nearly 8%. That’s a huge move.

 

MoneyMorning 25-06-18

Source: Bigcharts
[Click to open new window]

 

The impact of interest rates

In my view, the shift in thinking on interest rates is a big reason behind the move. Even though economic growth is good, the RBA is clearly concerned about the property market and the flow on effects for household consumption.

But the market’s response tells you that the RBA’s concerns are unwarranted. The shift in interest rate thinking is a boost for the banks, rather than being a needed defensive move for them.

In other words, the RBA cracked under pressure from property prices, right when they really didn’t need to.

I mean, the property market has been rising for years. Surely it can fall 5–10% without our central planners panicking?

This is the curse of asymmetric policymaking: Keep rates easy while asset prices are increasing, and keep them easy when asset prices are falling too. The former encourages speculation and the misallocation of resources, while the latter encourages the belief that central bankers will bail out the speculators if problems arise.

Former RBA board member Warwick McKibbin isn’t happy about it. He thinks the RBA should be preparing for a rate rise. From the Financial Review:

“The bank has backed itself into a position where it’s justifying where interest rates are based on inflation, and inflation is stubbornly low,” Professor McKibbin told The Australian Financial Review.

“So it continues to do the monetary policy injection, which in my view is driving up asset prices,” he said. “But it leaves them in a problematic situation where they have to raise rates when global rates are rising.”

The problem that nearly all central banks have is that thanks to their prior easy money stance, they are all dealing with highly leveraged economies that are much more sensitive to interest rate moves.

The US, thanks to its inherent strength and flexibility, is well into a rate rising cycle, but rates are still historically low. There is a good chance that a few more increases there will slow the economy, perhaps tipping it into a recession.

Given Australia’s household debt levels are that much higher than in the US, perhaps the RBA is right to be cautious about when to start the interest rate rising cycle? On the other hand, if they leave it too long, the window may close.

Thanks to past errors, central bankers are now damned if they do, and damned if they don’t.

 

Regards,

Greg Canavan,
Editor, Crisis & Opportunity


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing. 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. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


Leave a Reply

Your email address will not be published. Required fields are marked *

Money Morning Australia