–If you ask the Australian dollar what the Reserve Bank is going to do today – and the Australian dollar could actually talk – it would probably tell you “cut”. The dollar is certainly acting like a rate cut is imminent. At around 95 cents, it’s trading at its lowest level since December of 2010.
–But maybe the price of growth is headed lower because growth itself is lower. The Aussie has tracked the growth of the world and especially China. From the high 60s when we first moved here in 2005 to 110 early this year, the Aussie dollar is a proxy for global growth.
–Yet the Aussie fell 9.5% against the US dollar in September. It was the fifth-largest monthly decline since the currency was floated in December of 1983, according to Peter Wells in today’s Australian Financial Review. With price action like that, the Aussie could be whispering in your ear that the Age of Growth has peaked.
–This brings us back to the question we left off with yesterday. Are lower lows on the way? It was probably a stupid question to be honest. They’re already here, as you can see from the chart below. The All Ordinaries have not yet matched the intra-day low in early August. But if they follow the S&P 500’s overnight lead (down 2.85%), lower lows are indeed on the way.
Click here to enlarge
–How low? We’ll leave the technical projections to Slipstream Trader editor Murray Dawes. He’s got a new YouTube update in the works for later this week. Here’s a key excerpt from last week’s video. When you read the note below, keep in mind that the S&P 500 closed at 1099 yesterday.
‘If we go back down under that 10-day moving average again, which comes in around 1170, and back under yesterday’s low of 1163, that will create a nice pivot point…There’s just so many things out there that may bring this market undone…If this short-term uptrend is negated quickly, maybe even tonight…we could definitely see the move down to the bottom of the structure at 1100.’
–Where to next? Stay tuned for tomorrow’s update. And by the way, Murray’s free updates focus on the S&P 500. That’s an American index focussing on mostly Blue Chip American stocks. What does that have to do with Australia?
–The Australian stock market is still firmly coupled to the American stock market. This coupling happened during the Age of Growth. With the US dollar as the world’s reserve currency, US interest rates set the tone for global interest rates, especially since China pegs its currency to the US dollar.
–When America embarked on a huge credit expansion beginning in 2000, the global credit bubble ballooned. This was GDP growth fuelled by debt. The GDP figures got especially bigger in China. China’s export boom was made possible by Australia’s resource exports. That was great news for Australian stocks.
—When you’re in the early days of an Age of Growth, say 2003, then forward earnings estimates for miners are more useful than trailing price-to-earnings ratios. We remember looking at BHP Billiton in 2003 while working in Paris. On trailing earnings, it wasn’t cheap. But based on forward earnings projections, it had a P/E of about 9. That looked cheap, IF the big story about China was right.
–The big story about China is that it was about to industrialise at a manic pace. It would need lots of iron ore, metallurgical coal, and thermal coal. There is no such thing as just-in-time iron ore expansion, though. And with prices for iron ore negotiated on an annual contract basis, the Aussie miners were staring down the barrel of a big gap between supply and demand. The result is what you see on the charts below from ABARE.
–Triple-digit increases in commodity prices have a way of boosting corporate earnings. And the mana from heaven for BHP Billiton and Rio Tinto has been good eating for index tracking ASX/200 investors. BHP – with a diversified portfolio of commodity production heavily weighted to coal and iron ore – makes up 11.72% of the ASX/200. Rio Tinto, the pure iron ore play, is the 9th largest stock by market capitalisation on the ASX/200.
–The top 10 companies on the ASX/200 make up 52% of the index’s total market capitalisation. And two sectors alone – financials and materials – make up 63% of the entire market cap of the index. The ASX/200 is a growth index. Credit growth drives the earnings of bank stocks. And global credit growth drives the Chinese demand for BHP and Rio Tinto’s exports.
–Major stock market indices are supposed to provide you with internal diversification. You’re supposed to get a lot of different types of businesses that are uncorrelated. You’re supposed to get businesses that thrive in different environments.
–But you don’t get any of that with the ASX/200. You get an index that goes up when credit drives global GDP expansion. When credit doesn’t expand, you don’t get an index that goes up. You get an index that falls.
–Could China still save the day? It all depends on the “day of decoupling”. More on that tomorrow. In the meantime, click on the link if you want know more about how to build a truly balanced “Permanent Portfolio“.
for The Daily Reckoning Australia