Australian Stock Market, Gold Price Continue Dangerous Decline

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Today is a dangerous day for the Australian stock market. Our gut trading instinct tells us to look for a big intra-day reversal after a big plunge at the open. The futures market, spooked by last night’s massive selling in Europe, has priced in a big decline at the open. But after that, then what?

By our reckoning, the market has corrected its mistake of last August. No one appreciated the consequences of a bear market in credit at the time. Stocks rallied. Then came the fourth quarter for the banks and financials. It was a disaster.

Mr. Market has basically said, “Right, I got that wrong. The bear market in credit is a big fat negative for earnings and economic growth. A recession is coming in the world’s largest economy, and the Reserve Bank may put up interest rates again. Sell.”

You should think about buying this week. Very carefully.

Where’s the floor of the Australian stock market? If the ASX/200 goes a lot further below 5,500, investors are fundamentally reexamining their assumptions and expectations. The declines in Europe last night matched the figures posted in the first few trading days after 9-11. And as we write, the Dow futures are down a whopping 500 points, over 4.3%.

One interpretation for these moves is that we’ve entered a bear market and not a correction. So far, it’s looked and felt like a correction. But if it gets worse, it means the market will now acknowledge the serious rot in the global financial system, especially the credit markets. Stocks will fall at least another 5%, and probably 10%. The chart below shows why.

The post 9-11 market crashed 18%. It then rallied straight back up 21% in early 2002, before crashing again, this time by 22%. The early March 2003 was the low from which Australia’s long bull run began.

The past is not always prologue. But you can see the parallel. The August credit shocked wiped off all of 2007’s share gains from the Australian stock market. Then came the fake-out rally. Order was restored for awhile. Now the other shoe dropping, the one that acknowledges, as with 9-11, that something is fundamentally different about the world we operate it.

And what is that difference? The price of money is going up. So is the perception of risk. One visible clue is the yen. It’s getting stronger.

That’s bad news for emerging markets and speculative assets. Traders borrow in yen (where interest rates are low) to invest in higher-yielding assets like the Australian dollar. Yen strength means global investors are in full flight from riskier assets. That does not bode well for the Australian stock market and the Australian dollar, at least in the short term.

As you can see above, the yen is getting stronger against a basket of foreign currencies, especially against the dollar and the euro. The stronger the yen gets, the weaker you can expect global stock markets to be. You can see that Yen strength began right as the credit crisis hit in July. Since then, with one brief pause, traders have been getting out of risky positions and into… into what?

That’s a question you might want to ask whoever runs your superannuation fund. Professional money managers loathe being in cash. That’s what banks are for. But it would have made sense for money managers to increase their cash position late last year. Maybe that’s what happening now, a simultaneous liquidation/reduction in the amount of money investors have in stocks.

Investors are getting out of the line of fire. Again, we think it make sense to take a close look at stocks you want to own for the long term today. But we know it’s a hard thing to do. Psychologically, it’s fascinating to watch share prices fall. Emotionally, it’s agonizing. Rationally, you need to keep your wits about you.

Lots of concerned e-mail this morning. “I know it’s only the opening trades, but how’s that for blood on the streets this morning? Particularly the stocks I keep on my watch lists anyway which is mainly resources, they are getting smashed!”

Still, we wouldn’t be surprised to see Australian stock market draw a line in the sand at around 5,500. We don’t expect it to close on the lows today. We expect it to make a new 52-week low and then turn around. Woolworth’s, Telstra, and other non-resource blue chips will begin to look irresistible to fund managers who’s job is to stay fully invested in equities. Call options on the index would be a great trade today, if you were trading.

Your risk of calling a bottom is that valuations and earnings are no longer driving the market. If it were just economic expectations, we reckon the market would settle around 5,500. But something else is in the air too, fear.

When a fearful mob gets going, you’d better stay out of its way and keep a close eye on your capital. “Be greedy when others are fearful and fearful when others are greedy.” However, for very long-term investors, this week may present you with some of the best buying opportunities you’ll see in the next ten years.

The alternative-a worldwide financial panic-is certainly possible. Yet this is when it pays to tune out the din and crash of the press. Just step back a moment. Many investors are panicking right now. Stocks are oversold. While we are firm believers in the credit bear, we are not knee-jerk bears. The selling is already over done. Now it’s really just a question of timing your entry on the long-side and in the right companies.

In that respect there’s no particular rush. Let the sellers exhaust themselves. It will happen sooner or later. It often happens mid-day, when someone steps in to buy. We suspect that will happen here in Australia-if not today, then this week.

Of course we are mindful that there are still a lot of unknown unknowns out there. Sectors exposed to the credit crisis are falling like dominoes. The whole process of selling can feed on itself, especially with so much trading done by computer model. You get cascading prices.

Interest rates? Aussie producer prices rose at less than half the rate economists expected in the fourth quarter. But they were still up 2.6% over the same time last year. Consumer price inflation data comes out tomorrow. But our guess is that in the current financial environment-unless tomorrow’s data are an absolute shocker-the RBA will not put up interest rates. Not even 25 basis points.

Lower oil and commodity prices will take some of the sting out of inflation. And you might even see a bit of a “reverse wealth effect.” When the tone of the news becomes fearful and bearish, people reduce consumption and spending. The RBA should get all the benefits of a rate rise without actually raising rates.

And the gold price? It’s selling down like everything else. The American dollar’s gotten a boost from expectations of a Fed rate cut. Gold could decline to $800 on a technical basis if investor’s are truly spooked.

But how about this for a thought… prompted by big declines in U.S. equity markets, the Fed announces-between meetings-its super cut of 100 basis points. The market expects 50 and would prefer 75. But we expect Big Ben to surprise to the upside and deliver his wildest swing yet. In any event, the market has priced in a cut. When the news hits, dollar weakness and gold strength should resume. Stay tuned.

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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8 Comments on "Australian Stock Market, Gold Price Continue Dangerous Decline"

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Coffee Addict
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My professional advice would concur with what Dan is saying: – that is to carefully edge into some long term equity investments. There is certainly no rush if you hold a view that the market is now repricing itself around a moderate recession in the US. The market may dive further then rebound but I expect the repriced floor for the All Ords to be in the range 5000 to 5500. From here I would expect normal growth rather than exponential rebound (as occurred in the months after 9-11). Could it go down to a much lower floor? Maybe. The… Read more »
novosonic
Guest

bottom support level 2,100

gold down as speculators dump
to cover equity losses. $650
before return to $1.000,00

Dave
Guest

There are substantial economic and financial differences between 2001 vs. 2008. Today we have an unfolding housing implosion and credit contraction along with some of our largest financial institutions teetering on the edge of the abyss.

I’m solidly in the bear market camp.

kayle
Guest

Dave:

With you here.

The upcoming recession in the US will be unlike anything seen since the ’30s, as anyone who travels there much or has family there can attest.

There is no question whatsoever of the financial chaos that will unfold there, and is happening even now – my own concern is what will happen in the other large economies of the rest of the world….

Bob
Guest
I’m with Dave. “However, for very long-term investors, this week may present you with some of the best buying opportunities you’ll see in the next ten years.” There is very little in Australia that suits a value investor right now. The P/E ratios of most major stocks return approximately bank interest, at a time where interest rates aren’t high by historic standards, and people can already barely hang on to their houses. After selling starts to trigger a collapse, there are going to be bargains everywhere. In that environment, interest rates will rise as banks try to recoup their losses,… Read more »
Alec Holloway
Guest

This is not over! US banks and financial institutions have results for one quarter.Mortgages are illiquid and take time to unwind. most commodities are priced in $USD. Lower US interest rates=fallingUS$=rising commodity prices= inflation on a world scale. Uncle Ben just tipped petrol on the fire.

Commenter
Guest

Yesterday was a great day – all is wonderful. My moola’s on the cash side line (and a little bullion) since December and I’m watching the rot and loving it.

Only wish my stupid dog-super fund (Plum, subsidiary of MLC, subsidiary of NAB) had the possibility to short the market and a bullion option or even a mixed basket cash fund instead of 30 or so useless and similar BS ‘choice’ funds. A serious hole in their risk management offerings, and I presume many other funds too.

Ronald
Guest

GOLD IS GOING UP AND WILL KEEP ON GOING UP…SILVER IS GOING UP AND WILL KEEP ON GOING UP…STOCKS WILL BE LIKE THEY ARE SUSPENDED ON A SEE_SAW.IN THE CLOUDS ONE DAY DOWN IN THE DIRT THE NEXT…..TRADE ALL YOUR STOCKS FOR GOLD ..TRADE ALL YOUR MONEY FOR GOLD….GET SOME PMA(POSTIVE MENTAL ATTITUDE)

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