All Ordinaries Down 17%, Worst Showing in 30 Years

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Are you a glass half empty investor? Or a glass half full investor?

Investors open the week caught between two forces pulling them in opposite directions. Inflation is afoot globally. Higher commodity prices have been good for resource producer so far. But now everyone is worried that high raw materials prices will slow down industrial production. The world will pat its collective belly and say, “Sorry Australia, I’m full.”

You also have the added worry of a lousy financial year for superannuation investors. That is, balanced funds with your basic exposure to Australian and global equities will have had a lousy year. You can blame the All Ordinaries for this. It’s set to finish the financial year down around 17%. That would be its worst showing in nearly 30 years.

The financial year performance is what matters to super investors. But it doesn’t really tell you the whole story, does it? Since June 30th, 2003, the ASX/200 is up 72%. That includes the 23% fall we’ve had from the early November high of 6,828.

It all depends on how you define your terms, doesn’t it? A term, according the Latin definition, is a boundary or limit. But there are all sorts of terms. If you started investing in November of 2007, your time in the share market feels like a prison term. If you’re a U.S. homeowner who bought a house in the first quarter of 2007, it feels like a life sentence.

In the long-term, the conventional wisdom goes, you won’t do poorly investing in the broad market. You should ignore short-term volatility and focus on the long-term real returns above the rate of inflation, which you hope will be between 7-10%. And you know, if you look at a few charts, this long-term perspective is encouraging.

The RBA’s latest chart pack has three interesting charts. First there’s this little gem. It shows us that Australian stocks have clobbered the S&P 500 since the resource boom began. It also shows that while there could be more losses ahead, the long-term trend is still pretty bullish.

Australian and World Share Price Indices End 2001

Then there’s this little beauty. It’s an even longer-term chart. It compares the ASX/200 to the S&P 500 going back to 1994. There’s at least one bubble visible in this chart, and perhaps two, depending on how you view these things. The first is the S&P’s boom that ended in 2000. The index did make a new high in October of last year at 1,565. But where will it go from here? An answer in a moment.

Australian and World Share Price Indices End 1994

This last chart shows the leadership of the local market. Financials (the big four banks) have been the slow and steady winners for years. But the resource hare is lately clobbering the financial tortoise. Are banks a buy at these depressed levels? Are resources a sell?

Australian Share Prices

You probably can guess what we are going to say. We say it nearly every day anyway. But we will clarify it again as we begin a new financial year. The world’s financial system is full of an awful lot of rot. Slowly, reluctantly, but irresistibly, banks and brokers are being forced by shareholders and international capital rules to reduce exposure to risky assets.

Practically, this means financials will spend the rest of this year slimming down the balance sheet, selling assets and trying to stockpile cash. But just what assets will the hedge funds and Wall Street banks be selling? And who will they be selling to?

The first casualties of deleveraging will continue to be financial stocks themselves. These companies have massively bloated balance sheets with huge amounts of leverage. The big equity indexes were overweight financials and underweight energy for years. That’s reversing. Eventually, they’ll be overweight energy and underweight financials. But that is a few years off.

In the meantime, emerging markets had better watch out too. Brazil, Russia, India, China..the BRICs…will probably weather the storm. Each has something attractive about it that foreign capital will be reluctant to ignore. But the Pakistans, Vietnams, and Mexicos of the world had better watch out.

Is Australia an emerging market? Nope. But it depends on how you define your terms. Australia is thought of as a ‘risky’ market by some investors who see commodities as a speculation against a weaker U.S. dollar. If those investors see a greenback really in the second half of this year, they’ll sell commodities and buy the U.S. (as insane as that sounds.)

What does Australia have going for it? Well, for one thing, there is the cash rate of 7.25%. As painful as this is for individual Aussies, it’s a huge draw for foreign investors. The Reserve Bank will surely not cut rates when it meets in Sydney tomorrow. It should also give us a clue about the direction of rates for the rest of the year.

The Aussie economy looks strong. But you can tell that people are getting nervous. That’s the trouble with inflation. It destabilizes people psychologically and economically. There’s a lot of data due out this week that will show us what people are actually doing.

On Wednesday the retail trade figures come out as well as building approvals. We’ll also find out what demand for credit is like. Thos things will probably tell us what we already know. The economy is roaring along in some respects, and looking a little tired in others. That’s better than a lot of other places in the world.

The trouble with the long term is that it’s getting shorter and shorter every year. In the age of the 24/7 media cycle, with the Internet and mobile Internet, people receive and attempt to process information faster than ever. There are tens of thousands of variables, and investors somehow try to figure out what it all means on the fly.

But most of what flies over the newswires everyday is irrelevant garbage. You can try and trade it. But it is doubtful that much of what passes for news will actually affect your long-term investment strategy (if you have one.) The interconnectivity of markets makes them more volatile. But it doesn’t mean you shouldn’t think about long-term trends.

In the long term, as Keynes said, we are all dead. But in the short term, we expect to see the indexes lower but the resource shares generally higher. Gold and precious metals are due to take the baton of leadership within the commodities market. We are avoiding the still-bloated corpses of the financial stocks, which will not survive the coming revaluation in their current incarnation. Geopolitically? More on that tomorrow.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Name one,just one, Australian company with complete vertical (value chain) integration from material extraction all the way to point of sale for the final product to the end customer. As far as I’m concerned, the Australian has a head and a tail but no torso. The last remaining tyre manufacturing facility in Australia (located in Victoria) ceased operations this week thus resulting in the displacement of some 530 ex-employees.

    The inability of Australian manufacturing and processing to add value and their alarming rate of decline is an issue which extends far beyond mere cheap labour. I just don’t see why investors jump for joy at the news of secured price increases by the mining and energy sector when our lack of manufacutring potency and practically non-existent middle tier value-creation when clearly those nominal gains are subject to being eroded in the form of higher priced imports.

    A diminishing manufacutring presence is an erosion of bargaining power at the international trade level because (1) we are inept towards producing many of the things we consume in the quantity required and (2) the lack of a feasible alternative makes for a ‘take it or leave it’ situation with producers in the same manner we dealt with them at the starting leg of the supply chain. After all, a growing number of emerging economies offer significantly lower wages than say China, but just how many can produce in the same volume, at the same frantic pace, to the same standard and on the same scale as her?

    I know for a fact that a number of foreign entities having relocated from China into SE Asia to access lower wage scales end up moving back because those smaller fringe nations lacked the synergy and qualitative reliability to provide a stable and consistent delivery of contractual agreements. Capital infrastructure fragmentation juxtaposed with incomplete access to inputs, which had to be imported, posed logistical constraints which made the strategy impractical and difficult to manage in the long term.

    The absence of a viable production base is a fundamental value-generating deficiency which will continue to hurt as other economies intensity their investment towards developing comprehensive capital infrastructure and self-sustainability – now that’s a real threat. Being content with a purported ‘resources boom’ whilst performing perfunctory lip service to the need for comprehensive supply chain integration is shallow consolation as it limits our economic growth to two divergent vulnerabilities:

    One is our extractive industry serving as little more than an employee of offshore manufacturers who pay our wages, albeit one that’s quite lucrative for the moment.

    The other is driven by consumption which goes as far as the value reflected by our fixed assets and income – both of which are subject to deterioration as recent times have proven.

    Our upside is capped by how big a crater we’re willing to dig in our own backyard to maintain the status quo. The downside is an abysmal degradation in living standards as the US have come to realize in their eleventh hour. In time, it’ll come back to bite us in the R$.

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  2. Tom, your fight is with treasury, the likes of that wombat watching idiot Henry and his legions in Canberra and the banks. They vanquished industry policy in the 80’s. Button’s car plan was the last hurrah but the tide had already well and truly gone out.

    The “lets pretend we don’t pick winners” proletariat were dead against commercialising or making anything. Unless it was from 90% aluminium where the energy subsidy was king.

    Even in services they were all for tourism and financials but dead against transport services (remember “we are a nation of shippers but not a shipping nation”) & any software that required its own distribution.

    We can also thank the proletariat for stealing the financial inheritance from our grandfathers in the mutuals, carving up a good chunk among their mates, and then pissing the residual up against the wall going to take over the world buying dud banking and insurance assets without any prudential controls in places the UK and India.

    And finally, under “MacFarlane the cad” (he who lectured on the imperative for savings and the unsustainable asset inflation of residential real estate when he was the reserve’s aspiring deputy governor), they hit on this “real estate miracle economy” thing where the current account deficit didn’t matter. Well now the same bunch of commies in treasury are swapping treasuries for that same current account deficit RMBS. They are even to write bonds while we are running a budget surplus just so they can swap them for bloated “hot money” funded corporate debt that the foreign bank local branches won’t refinance at term.

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