The Booming Chinese Market You Could Use to Your Advantage

China market

Considering the turmoil you’re seeing in emerging markets around the world — especially in relation to currencies — Australian stocks continue to perform well.

Yesterday, the ASX 200 finished up nearly 0.8%, which is close to a fresh 10-year high. While Australia certainly isn’t an emerging market, we do share some characteristics.

That is, we have high debt levels and rely on foreign capital to sustain our standard of living. On the other hand, we have well protected property rights and a stable (if ineffectual) government. This means foreign capital inflows are relatively sticky. It doesn’t run from our shores at the first hint of trouble.

But that doesn’t detract from the fact that we are a small open economy, at the vagaries of global economic growth. More specially, we are particularly reliant on China’s growth, our largest export market.

And this is where clouds are gathering on the horizon. As The Wall Street Journal reports:

BEIJING—As China girds for an escalating trade fight with the U.S., it is facing increasing trouble on the home front from a slowing economy.

Spending on so-called fixed assets such as factory machinery and public works projects cooled to the lowest point in nearly two decades, the government reported Tuesday.

Other data also pointed to economic challenges. Retail sales grew, but not as sharply as analysts had expected. And unemployment ticked up to 5.1% last month, from 4.8% in June, the National Bureau of Statistics said.’

As the chart below shows, this is the lowest annual growth rate since 1999…

MoneyMorning 15-08-18

Source: WSJ
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Is the Australian market under threat?

Of course, the base from which growth is measured is much larger now, so high rates of growth are harder to achieve. Still, in economics and the stock market it’s all about the rate of change.

This slowdown bodes ill for Australia’s largest export market, iron ore. The main ingredient for steel makers is trading around US$68 per tonne. This is not too bad, and doesn’t indicate that the market is in trouble. Not yet anyway.

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If you look at the chart below though, you’ll see that iron ore is approaching an inflexion point.

MoneyMorning 15-08-18

Source: Optuma
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That is, over the past 18 months or so, iron ore has been in a correction/consolidation phase. That’s after it rallied nearly 150% from the January 2016 low to the February 2017 high.

These consolidation phases usually resolve themselves by moving sharply out of the triangular consolidation pattern.

The problem is, we don’t know which way prices will move!

However, the slowdown in China’s fixed asset growth suggests that risks lean to the downside.

Also consider the recent share price performance of Rio Tinto [ASX:RIO] one of the world’s largest iron ore producers. As the chart below shows, the share price has fallen sharply recently. The moving averages are in the process of crossing to the downside, the first time this has happened since the bull market got underway in early 2016.

MoneyMorning 15-08-18

Source: Optuma
[Click to open new window]

Can the stock market continue to move higher?

Yet the Aussie market continues to hold up! It’s at 10 year highs.

What’s going on?

Well, it’s a case of banks to the rescue again. As you can see in the chart below, the banks have staged a strong recovery since the public relations beating of the Royal Commission.

The Financials index (predominantly the banks) is up 10% in about two months. That’s a big move.

Banks are benefitting from the realisation that interest rates aren’t going anywhere. They will stay low for some time. In addition, the market knows that the property market won’t collapse while interest rates stay this low and employment remains strong. So ignore the property doomsday talk.

In addition to low interest rates you’ve got a falling dollar. The Aussie just hit a fresh 18 month low this week. That provides stimulus too. So all up, most sectors are doing well.

But just keep in mind that China is slowing. When iron ore prices fall, so does our dollar, and it’s usually not a good time for stocks when that happens. Maybe this time is different. Maybe something else is going on that I don’t know about.

But if China slows ‘too much’, foreign investors will soon turn their gaze to Australia. In the eyes of the world’s investors, we’re a derivative of China. That’s already happening to the extent that our dollar is falling. It reflects an increase in perceived risk. A lower Aussie dollar means an increase in purchasing power in foreign currencies. It’s like a stealth form of higher interest rates — to account for an increase in risk.

The question now is whether the stock market can continue to move higher as these risks build. The market is saying ‘yes, it can’. And at least in the short term, the market is usually right. But it’s worth keeping in mind the other signs emerging.

In particular, the iron ore price. If it breaks lower from its consolidation pattern, the market may reassess its bullishness.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

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Greg Canavan

Greg Canavan

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’.

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