Thursday, January 21st, 2016
Australian share market investors could be excused for thinking that the Australian sharemarket deserves a bit role in the recent smash hit movie, ‘The Big Short’ given its extraordinary volatility over the last 6 weeks. But is the market indicating some real problems or is it simply reflecting offshore events?
The chart below shows a 8% fall in the first two weeks of December, followed by a year end rally of 10%. Since January 1, the market has fallen again by nearly 10%.
Figure 1. S&P/ASX 200 (December – Present)
Source. Thomson Reuters Datastream
The hyperactivity has given rise to much speculation as to what is causing the recent falls. However the proper question may have been to ask what caused the miraculous end of year rally? Could it have been market manipulation or did Santa Claus just come late?
The volatility is shown more graphically in the next chart that covers the sustained 9 months correction since 31 March 2015. The rally in the index to 5300 at the end of December cut the correction to just 700 points or 11%. However, as at the 18th January the price correction moved towards 20% or nearly 1200 points. Since March the Australian share market has devalued by over $300 billion and a US domiciled index investor has lost about 35% on the value of their Australian portfolio.
Figure 2. S&P/ASX 200 (Since 31 March 2015)
Source. Thomson Reuters Datastream
The above charts and observations show that the Australian share market has arguably been in a bear market for the last nine months. The fall concurrent with a 15% devaluation of the Australian dollar reflects poorly on the Australian corporate sector. The stimulation from a weakening currency, growing employment, historic low cash rates and substantial inbound tourism growth is simply not transferring itself into higher reported profits. Indeed, if the $A had not depreciated since March then we can speculate that the share market would have fallen much further.
There are further issues that should be considered when reflecting upon the share market decline.
First, equity markets are predictive and the declines need to be analysed to see if they are giving investors an insight into the issues that confront the Australian economy. The sustained weakness in bank shares may suggest trouble lays ahead for residential property markets given the high exposure of Australian banks. The fall in resource stocks shows that the decline in the $A has not been sufficient to offset commodity price declines.
Second, the share market has declined despite the support of historic low bond yields. This suggests that the support to equity prices of lower risk free rates is being totally offset by lower earnings projections. The market is reflecting sustained lower growth and possibly a deflation or very low inflation cycle; and
Third, the market decline is in spite of a solid rise in employment that normally suggest that income, consumption and therefore the economy should all be growing solidly. The contradiction seems to be created by slowing income or wages growth that could be symptomatic of growth in low paid services jobs rather than higher paid skilled occupations. The transitioning of the Australian economy seems likely to result in lower per capita real wages.
Notably many commentators have laid the blame for the recent market decline on the economic machinations in China. Whilst the Chinese economy does and will have a significant effect on the Australian economy it appears to us that it is overused and is a convenient smokescreen for avoiding a proper economic analysis of the difficult outlook for Australia. Indeed this is where the stock market, when free of manipulation, does paint a realistic picture of the future. Therefore the recent correction, in the context of nine solid months of declines suggests that the economy is in for a tough period in 2016.