The ASX/200: Were the Past Four Years the Exception and Not the Rule

Year to date, the ASX/200 is now up exactly... zero, although it begins today imitating New York's anemic overnight recovery. Why has the ASX/200 outperformed the Dow to the downside? Probably because it outperformed it to the upside, and because Australian firms have more to lose from a China slow- down than American firms. American firms, by the way, have their own problems.

At the close of market on action on February 26th, the ASX/200 was up nearly 18 per cent over the last six months. The Dow, by comparison, was up just seven per cent. It's not surprising then that the local market has taken a bitter pounding.

As bad as it feels, the local benchmark is STILL up 18 per cent over the last twelve months, doubling the Dow's 9% gain. And harken back to 2003, when the ASX/2000 closed March 9th of that year at 2,741. Using yesterday's trading price of 5,689, that gives the index a 107 per cent gain, just passively following the index.

We mention all this as a prelude of sorts. The conventional wisdom is that if you're invested over time, days like the past five are merely inconvenient bumps in the road. Stay invested for the long haul and the market will make you rich, goes the mantra.

But what if the last four years on the ASX/200 were the exception and not the rule? What if the rise in Australian shares is a one-off bonanza on China's resource- intensive transition from communist backwater to industrial powerhouse? And what if the glory days are already behind us?

That's a lot of what ifs. What about facts? According to today's ABARE report on Australian commodities, we may be witnessing the peak in the value of Australian commodity exports. Even though export volumes are projected to increase in the next few years as new capacity comes on-line, addition of new capacity from elsewhere will mean falling metals prices (as well as projected falls in iron ore and coking coal.) Easy explanation: flat growth in nominal dollar volumes... but a key difference in the composition of the figure, with greater volume compensating for falling prices.

Specifically, the report reports, "Reflecting assumed relatively strong world economic growth, and hence higher commodity demand and export shipments, the value of Australia's commodity exports is forecast to be around $147.6 billion in 2007-08, 7.1 per cent higher than a forecast $137.8 billion in 2006-07. Over the medium term, the value of Australian commodity exports is projected to rise in real terms in 2008-09, before gradually easing toward the end of the projection period. By 2011-12, Australian commodity exports are projected to be worth around $140.6 billion (in 2006-07 dollars), 2.0 per cent higher than the forecast value in 2006-07."

Not that any of this is figuring into equity prices this week. But it's a thought. It seems to us that the strength of Australia's stock performance the last four years could be its weakness going forward. It's good to be overweight resource and financial stocks during a bull market in resources and financial stocks. It's bad when resource growth tapers off and you see a general contraction in global liquidity. This general lack of sectoral (even economic) diversity remains the chief liability to depending on the local share market for all your superannuation needs. Too few eggs. Just one basket.

We took a look at the intra-day trading pattern for the day over the last few days and blurted out some observations to our colleagues, who tolerate our exasperated outbursts. When the market closes on the lows, it usually means there are sell orders on the order books waiting to be executed. The market generally opens lower next day until the orders clear and a new (temporary) equilibrium price is established.

But then we saw today's Dow chart and we were reminded of a particular section of Jesse Livermore's stock market classic, "Reminiscences of a Stock Operator." Reflecting Friday's selling overhang, the Dow opened down a quick sixty nine points, from 12,109, to 12,140. And then sellers seemed to step in, steadily driving the index up for the next two hours to an intra-day high of 12,186. The rest of the day was marked by oscillations between sellers and buyers, with the market eventually falling another sixty points in the last half our of trading to close near the lows for the day at 12,050.

A casual (or lazy) observer might call this kind of trading action "directionless." But to us, it looks like a "managed distribution of large position." Huh?

Let's say you're a seller on the ASX/200 or the Dow. Maybe even a short seller. You read the market tea leaves and reckon there's another five to six per cent downside. But as an experienced seller, you know it's better to sell in a rising market than a falling market. You get better prices that way. But to sell in a rising market you need a rising market. And a rising market needs buyers. Enter the covering short sellers.

Looking to cut their losses, short sellers enter back into the market and repurchase the shares they borrowed months earlier. This appearance of new buying strength pushes stocks up, giving casual (or inexperienced) observers the correction that the market is finding its feet (on the floor.) But maybe it's not. Maybe what you're seeing is buying interest from short-sellers coming in enough to allow them (and anyone else with a large position which they wish to unwind) to do so with the cover of a rising market. It's an advantageous retreat which generally leaves the public as buyers and Wall Street as the seller.

We wouldn't exactly call this market manipulation. But is a very good example of the interests of Wall Street are not always strictly aligned with the interests of the man in the Street. Livermore describes this managed liquidation the following way, "Usually the object of manipulation is to develop marketability - that is, the ability to dispose of fair-sized blocks at some price at any time. In the majority of the cases the object of manipulation is, as I said, to sell stock to the public at the best possible price. It is not alone a question of selling but of distributing."

The best way to unload your shares is to create a rising market for them. And the best way to do that is to buy them at the margin, turn around the trend, get the public back in, and thin liquidate with the cover of the crowd. He continues, "Stocks are manipulated to the highest point possible and then sold to the public on the way down. When it came to the actual marketing of the line he did what I told you: he sold it on the way down. The trading public is always looking for a rally... "

During bear market rallies, it is usually the public buying what Wall Street is selling. The intra-day action of the Dow today looked like a bear market rally, which indicates to us that it's not a good time to buy.

If there's anyone happy with this recent decline in markets, it's got to be the private equity crowd. "Private equity, funds stoic about share sell-off," we read in Reuters. Can a man in a suit be stoically gleeful? If the shoe fits... Private equity must relish the fact that they may not have to pay such steep premiums in this kind of market. There are a lot fewer buyers today than say, a month ago. And there will be a lot of stocks on sale (vulnerable) to leveraged buyers. Watch out Coles, and Chrysler.

Dan Denning
The Daily Reckoning Australia

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