Why Are We Experiencing A Market Correction?

A downward stock market trend

And now for the bounce…

US stocks jumped more than 2% overnight as last week’s panic selling turns into panic buying, also known as short covering.

When traders ‘short’ the stock market, it means they are betting on declines. In order to short stocks, you first borrow them from someone (for a fee), promise to return them at a later date, and them sell them in the market.

You then hope that the share price falls. Assuming prices do decline, you buy the stocks back at a lower price, return them to the owner, and pocket the difference.

Overnight, it looks like lots of short sellers bought back stocks (covered their shorts) which lit a fire under prices.

This is pretty standard behaviour for a market that recently plunged around 7%. It doesn’t mean the worst is over. It’s simply a rebalancing of a short-term oversold condition.

Given the decline in the Aussie market (from its peak in August) has been worse than in the US, you expect a decent rally in our market today. Yesterday the ASX 200 jumped over 30 points (0.56%) and futures indicate another 30 point rise today.

However, our market is still in a very deep hole (as you can see in the chart below). The recent correction represents a decline of just over 9% from the peak. That compares to a decline of 5.1% earlier in the year.

MoneyMorning 17-10-18

Source: Optuma
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Why the major sell-off?

That is a solid dumping of stocks. Why the panic?

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As I’ve pointed out previously, Australia faces quite a few headwinds in 2019. And the market, in its wisdom, has all of a sudden decided to price these headwinds in.

Here are the issues, in no particular order of importance…

The prospect of a Labor government next year is the big one. Let’s face it, having ‘red’ Bill Shorten in the leader’s seat won’t be good for stocks. Labor is right behind the Paris Agreement and takes the moral high ground on climate change.

What many people don’t realise though is that whatever action Australia takes on carbon emissions, it won’t make a speck of difference to global warming.

We produce just under 2% of the world’s carbon emissions. But on a per capita basis, our emissions are high. That’s because we have traditionally used our cheap and abundant coal reserves to generate electricity.

On the other hand, China produces 30% of global carbon emissions. Check out this chart from Bloomberg:

MoneyMorning 17-10-18

Source: Bloomberg
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China’s emissions started rising sharply after it joined the World Trade Organisation in 2001. This was when ‘globalisation’ kicked into gear and multinationals moved their manufacturing base to China to take advantage of no environmental or labour regulations.

Even the liberal Bloomberg concedes that climate change efforts are useless without China:

To its credit, China has made moves to limit coal use. But the country’s emissions continue to rise.

This leads to a painful but inescapable truth — no matter how much they spend, no matter how dramatically they change their societies, the U.S. and Europe won’t be able to put much of a dent in global warming on their own. Yes, the U.S. should ban coal power, tax carbon heavily and spend lots of money on building green energy infrastructure. But without a huge change in China, none of that will matter — the battle against climate change will be lost.

Yet Australia continues its hysterical debate about climate change. We are being sold out to unelected technocrats instead of engaging in sensible debate about how we reduce our per capita emissions over the long-term, in a way that doesn’t set our economy back.

There are other reasons why the market doesn’t like Shorten, but you get the gist.

Australian economy’s impact on the market

What else is the market freaking out about?

Well, the Royal Commission into the banks is causing a tightening of credit, which is putting further pressure on Aussie housing prices.

High petrol and electricity prices are an additional tax on consumers.

Housing construction is slowing down sharply. Look at the price of building materials company, CSR Ltd [ASX:CSR]. It’s down 40% since peaking in May.

MoneyMorning 17-10-18

Source: Optuma
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The biffo between China and the US is starting to have an impact on Chinese growth, as reported by Reuters:

BEIJING—At week’s end, global investors and policy makers will likely be given a stark reminder of the costs of a bitter Sino-U.S. trade war, with a Reuters poll predicting that China’s third-quarter growth will slow to its weakest pace since the global financial crisis.

Domestic demand has been faltering in recent months as U.S. President Donald Trump’s campaign to force China to make sweeping changes to intellectual property, industrial subsidy and trade policies start to depress export earnings.’

Finally, Australia is now starting to have a debate, and concerns, about immigration levels. The issue is the ability of cities to absorb large numbers of new people with putting strains on infrastructure. Better late than never I suppose…

The problem here is that population growth has been a key plank of Australia’s economic growth policy for years. If you strip that out and look at economic growth on a per capita basis, our growth is much less impressive.

Combined with all the other issues mentioned, lower immigration now will lower growth even more. But what do you expect? This is what happens when you have reactive, not proactive, political leaders.

In short, you reap what you sow. And Australia is about to reap a pretty bare harvest.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

PS: In this free report, economy expert reveals four ways you could cash in on the global infrastructure boom. Download this report now.

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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