ASX: All Ordinaries Follow Wall Street, Crash Hasn’t Happened…Yet

“Crisis puts home ownership out of reach,” reports the front page of today’s Herald Sun. “The Victorian Supreme Court issued 2734 possession orders in the year to June – a rate of 52 a week. That is up from 897 orders in 2001. In a further sign of the distress, there has been a blowout in insurance claims by home lenders who lodged claims for $210 million worth of bad loans.” And all this before the Reserve Bank meets tomorrow, when it will probably hike rates again.

Despite the bad news from the home fires of the real economy, the Aussie market may follow the US up today. The Dow punched back in Monday trading, gaining back nearly all of the ground it lost on Friday and closing up 286 points on the day. The big rally came in banks, brokers, and mortgage lenders, with dead cats bouncing everywhere on Wall Street.

Colour us skeptical of a rally led by financial shares. We eventually expect to see a decoupling of the Aussie share market with the American market. But it’s important to remember that four of the biggest five stocks by market cap in Australia are banks and financial stocks. You’ve got an entire industry quaking in its boots about bad loans, lost trading revenues, and a murky climate for investment banking profits. It’s not surprising that they’d generate some activity by bottom fishing in their own sector.

Here’s the thing; what we’ve seen so far is a correction, not a crash. In Australia, for example, yesterday’s close at 5,949 left the All Ords down 509 points from the July 20th closing high of 6,457. That’s about a 7% “correction”. Another 150 point drop would get us to a real, bonafide, 10% correction. But right now, the All Ords are still up 4% on the calendar year, having begun the year at 5,672. And the Dow, despite its swoon, is up nearly 8% on the year.

That’s the scary news, then. We haven’t seen a real crash yet. And of course, maybe we won’t. But if you saw Jim Cramer freaking out on TV last week telling Ben Bernanke he had “No idea how bad it is out there,” then maybe you got the feeling that there are a lot of money shufflers in the financial markets who’d love to see a little rally where they could liquidate their positions in a rising market. It’s much less pleasant to sell in a market that’s sinking like a stone.

In any event, the fireworks aren’t over. Many billions more in subprime mortgages reset over the next 18 months, according to my friend John Mauldin. Who is the ultimate owner of this risk? We’ll find out soon enough.

Meanwhile, oil prices fell to US$72.06 in New York trading. OPEC plans to increase production. And there is a growing worry that the American mortgage mess will threaten oil demand. A slower growing economy uses less energy. There is also the interesting matter of how much the current oil price is a function of financial demand. Are traders closing out long-oil positions and accounting for some of the falling price?

It’s probably a combination of all these variables. But we can tell you one thing: we think the market for oil is going to be a lot more liquid and robust than the mortgage market in the next twelve months. While we wouldn’t be bargain shopping in the financial sector, the recent correction (and whatever other declines we get) does present an excellent buying opportunity for long-term energy bulls.

The US dollar index briefly traded below 80 yesterday. It hasn’t done that in 15 years. Global confidence in America’s currency in and the soundness of its finances is quickly unravelling, and not in an orderly way. Long-term, we think it means a global reallocation of assets out of the US dollar and into other currencies and markets. This should be good for Australia. But in the short-term, it’s going to be a painful transition.

Remember Goldman’s Alpha Fund? It’s the hedge fund run exclusively for the employees and friends at Goldman Sachs. It was down 9% in 2006, a rude little shock. It’s down 12% so far in 2007, with 9% of that decline coming in the last two weeks. Looks like a lot of people were slumming for yield in the CDO market.

Dan Denning
The Daily Reckoning Australia

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