Is Today’s Market More Volatile Than Past Markets?

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The objective of today’s Daily Reckoning is to tackle the question of whether today’s market is more volatile than past markets. If it is, how you invest, trade, or allocate your assets would be affected, and probably have to change. But in order to make that determination, we first have to define volatility and then have a look at the market data itself.

Before we get to all that, though, let’s deal with some mainstream reporting, some production figures from the resource sector, a disturbing report from Harvey Norman, and an even more disturbing report from the Australian National Audit Office (an agency you may be hearing a lot from in the coming years.)

“Consensus is beginning to emerge among economists and market analysts that the recovery in the Australian share market will be sustained, and some brokers are encouraging their clients to start buying now,” reports an article in today’s Age. As the Mogambo says, “HAHAHAHAHAHAHAHA!”

Wouldn’t it have been better to buy on the March lows instead of now, when the market is almost 30% higher?.

Maybe that’s unfair. We didn’t predict the March rally any better than anyone else, although we did persist with recommending at least one stock per month in Diggers and Drillers. But our main point is that you should be very cautious when the brokerage industry starts shouting for you to get back in the market with both feet and all your cash.

Anytime it’s safe to express an opinion on the front page of the paper without being contradicted or laughed out of the room, you ought to give that opinion a wide berth, or at least a huge dose of skepticism.

Besides, opinions about the markets are like left ear lobes; everybody has one. What you want are investment ideas, not opinions. And right now, we reckon the best ideas are coming from a review of first-half production figures and cash-flow statements. If you can find a business that’s managed to keep costs down and the cash flowing, despite lower commodity prices, well then you may be on to a winner.

What about retail? Harvey Norman shares fell 6% yesterday-and that was after the company reported that sales were up 3.8% over the last twelve months to $6.03 billion. The devil was in the details. Same-store sales growth was up 1.4% in the fiscal year, compared to 4.4% growth the year before. And the overall sales growth rate was down over 50% from the 8.7% rate the year before.

Is that nit picking? Growth is growth isn’t it? Shouldn’t any increase in sales be a tribute to what Access Economics calls “the remarkable resilience of Australia’s mums?” Isn’t confidence the most important thing in a consumer economy?

The Access analysis has to be one of the stupidest pieces of economic analysis we’ve ever read. As if Australian mums will manage to defy the necessities of reduced consumption in a balance sheet recession to return the nation’s economy to a pre-bust glow. Absurd. Confidence matters. But whether you have money to pay your bills or buy a new DVD player matters more.

Our guess is that retail figures are going to suffer as households shift their mindset from spending to saving. We’re talking about a sea change in consumer behaviour, not a cyclical rebound from an ordinary recession. You may disagree. But if this is a balance sheet recession and not just a garden-variety recession, households will gradually reduce debt, use fewer credit cards, and begin to live beneath their means again.

As we mentioned yesterday, we think the LNG industry may be Australia’s next big export winner. And today, we’ll give you some proof, or at least an argument. The Australian Bureau of Statistics released data last Friday that show Australia’s export prices plummeted in the June quarter-but not for all commodities.

The Export Price Index is important for a lot of reasons. But it’s probably most important because it’s a measure of Australia’s national income and the terms of trade. If the country is making more because it’s selling more, and what it’s selling is going up in price, this means it has more money to do other things (like service the interest on a growing public debt).

But if there are major changes to the structure of the nation’s income, well that’s the sort of thing you’d want to pay attention to. For the record, the Export Price Index decreased by 20.6% in the June quarter. It was the largest quarterly decrease since the current series began in September quarter 1974.

According to the ABS, “The decrease was driven mainly by falls in prices received for coal, coke and briquettes (-36.8%) and metalliferous ores and metal scrap (-23.5%), as well as the appreciation of the Australian dollar against all major trading currencies. These falls were partly offset by rises in prices received for petroleum, petroleum products and related materials (+12.9%).”

One quarter does not a long-term trend make. But we’d argue that the June quarter indicates a shift in the balance of earning power for Aussie exports. Steel-making bulk commodities (iron ore and coking coal) may suffer from increased production or excess capacity in steel-making countries like China, Korea and Japan.

Energy, on the other hand is probably a more durable investment bet. Of course there are people that predict energy prices-especially for an oil substitute like LNG-are only rising because of the actions of speculators and that high inventories and tepid global growth mean oil prices are headed much lower this year, not higher.

That difference of opinion (different analysis of the same facts) is what makes it a market, though, isn’t it? There is a strong historic correlation between GDP growth and electricity production. The thing we like about LNG is that it’s not coal. It’s a cleaner-burning fuel to produce electricity. And at some point, steel-intensive growth in China is going to give way to a more balanced consumer economy (perhaps with a lot of hybrid electric cars). This, to us anyway, argues for a big shift to energy (and LNG) as Australia’s most valuable energy export.

The transition to that status will be volatile though. In Monday’s Wall Street Journal, Robert Matthews reports that, “The world’s biggest miners and steelmakers are on the brink of forging a new system for setting iron-ore prices that is expected to increase the volatility of steel prices, but perhaps make the process more transparent.”

What’s at stake here is control of iron ore pricing power. At last year’s Agora Wealth Symposium we argued that control of pricing power was switching away from the steel-producers in Asia and to the iron ore producers in Australia. But that was before the credit crunch led to a sharp drop in global industrial production and Asian exports and a big fall in spot prices for ore.

Now, it’s a bit of a draw to see which party will control the ore price. And no one really expected the Chinese to complicate the issue by arresting Rio Tinto executives. That’s a dangerous kind of leverage that may not work out exactly as intended (a more compliant Australian ore duopoly that is less threatening to Chinese interests).

But just to show that the Rio showdown with China is good theatre but not the start of a bitter, confidence-destroying feud between Shanghai and New South Shanghai, Bloomberg is reporting that China Shenhua Energy Company-China’s largest coal producer-has been given permission to buy land in New South Wales by the Australian Federal government.

Shenhua is 68% owned by the Chinese government. The story says the Foreign Investment Review Board approved Shenhua’s purchase of six farms “of about 2,000 hectares.” Last year, the company paid the New South Wales government A$300 million for an exploration lease near Gunnedah, where it reckons there may be 500 million tonnes of coal just waiting to be dug up and mined, beginning as soon as 2013.

Selling pieces of land with valuable resources to foreign governments in order to paper over large structural budget deficits is not exactly what we’d call great statecraft or prudent management. But it does show you that Australia’s national income is directly influenced by how it chooses to handle “the resource question.” Sell the assets outright for a few hundred million now? Or try, in some cases, to benefit from more value-added commodities without surrendering ownership of the assets?

One sure result of the all this is that if ore prices are set quarterly and not annually, they are going to be a lot more responsive to monthly changes in steel supply and demand. That makes for more efficient, market-based pricing. But it also makes for more volatility in the price, and probably in the share prices of the major and junior miners.

One last point on national income and accumulating debt. The trouble with being a debtor is that you gradually surrender a larger share of national income or assets to your creditors. This is probably something we’ll talk about at next week’s debt summit.

Today’s let’s just put in a California-kind of perspective. As you may know, California is facing a huge debt crisis. It’s spending exceeds its revenues. Its legislature can’t come to an agreement on the right combination of revenue-producing measures (taxes) and spending cuts (government services).

That assumes there IS a right combination. No one is really wondering whether the whole structure of the modern welfare state has simply hit the wall, with California-as usual-at the leading edge of the storm.

But Australia is drifting toward its own Federal budget Catch-22. The two charts below-taken from a presentation by the Australian National Audit Office-show that the second-largest contributor to Federal government revenues are “company and petroleum resource rent taxation.”

The Federal Government’s Cash Sources

One issue to watch in the changing nature of export prices is a reduction in government revenues from resource rent taxation. By the way, we’re not entirely sure what the Audit Office means by that. We’ve called and left a message.

But the numbers are what they are. Revenues fell by 4% to $291 billion in the last fiscal year. That was a combination of individual, corporate, and excise taxes. Meanwhile, as they tend to do, expenses rose to $338.2 billion. You can see that from the chart below.

The difference between revenues and expenses, if the latter is greater than the former, is what we call a deficit. The way you eliminate it is to increase revenues or reduce expenses, or some combination of both. The trouble is, increasing revenues through taxes means removing potential business and household spending from the economy-not exactly a good idea at the moment.

But if you reduce government spending, doesn’t that reduce stimulus too? We’d argue it doesn’t. We’d argue that the government could probably be 30% smaller and Australians would get by just fine. They’d keep more of their money and expect less in the way of services delivered inefficiently by the government.

How the Government Spends Your Money
(or money its borrowed for you to repay later)

In any event, the numbers show a gap is forming between what Australia’s government takes it revenues and what it spends. You can’t bridge that gap by selling off the national silver ware. That leaves reduced spending – something the government has committed to. But it’s awfully hard to win elections when you can’t give other people’s money away to your voters. It should be an interesting eighteen months.

Of course, if the economy booms ahead and confidence is restored and tax revenues bounce back faster than expected, well then we’ll just close up shop here at the Old Hat Factory and go open a coal mine somewhere. But somehow, we think the budget gap will get a lot worse before it gets better. More on that tomorrow.

Dan Denning
for 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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25 Comments on "Is Today’s Market More Volatile Than Past Markets?"

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watcher7
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In this article Dan wrote: “We didn’t predict the March rally any better than anyone else…”. But is this true? This is what James Stack had to say in mid-March: “While there has been “no place to hide” in this bear market, there is extraordinarily good news on the horizon. For regardless of whether one argues that the bear market bottom is at hand, or still lies ahead in the future, it is a historically indisputable fact that we are heading toward a buying opportunity of a lifetime. Here’s why… “Could last Monday’s low have been the bear market bottom?… Read more »
Greg Atkinson
Guest

watcher7 when I suggested earlier this year here on DR that things seemed to be sorting themselves out the gold bugs and doom crowd told me I was being fooled by a “suckers rally”. You can read what I had to say back in March on the shareswatch blog here: QBE and the ASX All Ordinaries and in April here: World stock markets rally: is the bear back in its cage?

As I have mentioned on a few occasions here, sometimes a bear market is just a bear market…even if it is a nasty one :)

watcher7
Guest
Greg, on January 20 of this year I posted this: “What the Pittsburgh Steelers predict for the stockmarket: History suggests that the Dow Jones Industrial Average is on the cusp of a 70%+ rally over the next couple of years. It may even pass the 2007 high.” This was after I was looking for the rally to begin in the 4Q2008. * Matt Townsend, U.S. Stocks Advance on Caterpillar Earnings, Bernanke Remarks, bloomberg.com, July 21, 2009: “Most people missed the lows and continue to treat this as a rally in a bear market,” said Jeffrey Saut, chief investment strategist at… Read more »
Pete
Guest

Nice article.

I would take a stab and say that our revenues for this financial year will be down near 250B. Lower revenues, higher costs…as Dan points out, something has to give there.

Higher taxes or less spending? Neither look very politically popular do they.

So, back to holding on to that vague hope of a resurgent resources boom bourne by the internal restructuring (therefore increased demand) of a country we know not much about.

Pete
Guest

Maybe 250B is a bit harsh…lets have another stab at 270B instead.

beyondtool
Guest

A friend who works in the furniture section of the Major Gold Coast Harvey Norman Store says they haven’t moved any furniture in months. If she didn’t have rainy day savings she would be broke and on the street (Harvey Norman stores pay commission to most staff based on sales..that’s why they either pester you or ignore you completely).

I’m not sure how much of the current depression is being hidden in positive figures, but at some point the pain will have to be dealt with.

Ned S
Guest
beyondtool and Annie – beyondtool: My thought is that rather than the pain having to be dealt with “at some point”, government’s goal is to stretch it out over many years. And very much share it around in the process of course. Annie: Thanks for the “snot and tears” comment – I love a good laugh and that comment of your’s worked for me! But happily some Oz families still reckon their oldies are worth more alive than dead – There was an old boy I heard about some months ago whose mob fought the doctors tooth and nail to… Read more »
Ned S
Guest
Pete – What are your thoughts on Oz residential RE? As you know I’ve been bearish on same for a while now – But never to the point of more than 20% declines. My current thoughts follow: * Central banks are not going to allow the world to crash and burn in a deflationary manner. * In our brave new world of investing, government intervention has become an overriding consideration. * The Oz government in particular, will protect (and if necessary, stimulate) housing – Our national economy simply isn’t well diversified enough not to. And yes, that means that the… Read more »
Pete
Guest
Ned S: My views are the same, I think it is just a matter of time before the crunch hits. I am finding the delay quite interesting though. Lessons to be taught all over. “Despite the fact that I feel Oz residential RE is overpriced, the ROIs are still acceptable.” – you mean, the ‘current’ ROI’s are acceptable. Besides all the costs involved. And potentially increasing council rates. And the fact that you won’t be able to easily offload such an investment at a positive return if you need to. And the huge potential for more rental competition in the… Read more »
Justin
Guest

The government still has ‘room to move’ with interest rates i.e. downwards, to put a bid under the property market, or any ponzi scheme that’s going really.

The Australian dollar won’t stand up to the assault but I guess that’s the whole idea, to screw the workers and the savers.

Sell dollars, buy gold and screw the government. They just made a ‘profit’ selling their own liability high and buying it low, good work if you can get it!

Pete
Guest
Justin: “The government still has ‘room to move’ with interest rates i.e. downwards, to put a bid under the property market, or any ponzi scheme that’s going really.” If I am reading you correctly, the RBA won’t touch rates. They have a conundrum as it is – fight inflation or support credit? But ultimately they have no more effect in reducing rates. All they do is talk and try and justify their existence (admirably too), but if you read between the lines they only have two tools left at their disposal: – increasing rates (unlikely!) – printing money (another topic… Read more »
Justin
Guest

The RBA is in no way independent, it is just an arm (or is that tentacle?) of the government. If the government wants interest rates lower the RBA will provide. They still do have room to lower rates, they can go to zero just like the BoJ and the Fed.

Won’t help the dollar though.

Ned S
Guest
The RBA is jawboning. It doesn’t want to lower rates. Because core inflation is uncomfortably high. They reckon it’ll drop over the next two years – Maybe? But very just maybe more jawboning! (It does become hard to trust a pack of jawboners.) But would they lower rates to protect housing (and even more especially banks) at the risk of seeing high inflation? Yes, I surely do believe they would – Even though any rate flow-ons to consumers will be minimal, they’ll keep banks in profit. Which is a very good thing for all. While I don’t like seeing all… Read more »
Pete
Guest
Justin: “They still do have room to lower rates, they can go to zero just like the BoJ and the Fed.” But what would lowering rates do? The answer is nothing. It might give the Gov something to whinge about to the banks though. Ultimately lowering rates, as you say, would be bad for the dollar. Which means bad for banks who borrow from overseas. Which means higher rates. So the RBA lowering rates does nothing good at all. It wouldn’t even really lower mortgage rates. And that is my point. The RBA is smoke and mirrors on that front.… Read more »
Justin
Guest
What the RBA wants is irrelevant, as I said it is just part of the government. If the government wishes lower rates, lower rates there will be. The housing market is just one ponzi scheme of many, including the dollar itself. Therefore, the supply of fools must be maintained. How else can the scheme continue unless the government, (using your money) backstops the mortgage market? i.e. you, the saver (in dollars) are the greatest fool. The RBA backstops or ‘guarantees’ the mortgage market by buying mortgage paper and as you know, buying bonds raises their prices, the same as saying… Read more »
leela
Guest
Justin – “The housing market is just one ponzi scheme of many, including the dollar itself.” Yeh, I wonder sometimes, what will govt do. Govt will either have to support the ponzi scheme and the flood of debt dumped onto the economy by the commercial banks for over-priced RE, or protect the dollar when offshore lenders pull the plug. What can govt do, ramp inflation by cranking the printing press, or up interest rates and decimate borrowers – hello negative equity, are you my friend? Either way it gets an implosion. Would have been smarter to guide the economy in… Read more »
Ned S
Guest

Thanks for the answer Pete – I’m keeping an eye out for any housing specific policy changes plus ones aimed at things like giving the RBA a mandate and more effective tools to deal with bubbles.

http://www.businessspectator.com.au/bs.nsf/Article/Twisting-in-the-wind-pd20090522-SA6PF?OpenDocument&src=is&cat=financial%20services

Pete
Guest
Justin: You make some good points. Perhaps we are misunderstanding each other when I suggest that if the RBA lowers rates it will be pointless. Sure, they can lower them to zero if they so desire, but then they risk all sorts of other things and at the same time the banks won’t be lowering their mortgage rates significantly. I believe that without legislation, nationalisation or some kind of bailout system, you simply won’t get the banks to lower rates. Now the RBA faces that lovely conundrum – raise rates to fight inflation or lower them to save the RE… Read more »
Pete
Guest
Ned: That’s an interesting article – the Fed and RBA fighting bubbles. Ultimately I don’t think they will fight them, if human nature is anything to go by. The reason I say that is because being in a bubble is excellent at the beginning. Everyone jumps on the bandwagon and profits (if you can call them that) are made by most. Especially at the start, they seem very much like ‘prosperity’. And therein lies the problem. Since when has curtailing ‘prosperity’ been an election winning idea? Since when has it been even slightly popular? Oh sure, it is popular in… Read more »
Biker Pete
Guest
Politics isn’t brain surgery. The proposition ‘First do no harm’ cannot apply, since _any_ major policy change will affect some sectors of the community very adversely. Even the best intentions in policy implementation (eg., abolition of negative gearing) quickly have unexpected, lasting effects. Funicello’s adage about ‘plucking a flower’ causing the ‘troubling of a star’ is probably more applicable to financial equilibrium than to the environment. Apparently, if one can believe the recent news from Oz, investors are flocking back to realty. If true, why? In our case, the new super rules have meant we’ve _halved_ our annual contributions because… Read more »
Greg Atkinson
Guest

Ned S – well the Medicare Levy is on the way up. The first of many tax hikes, levy increases etc. that will roll across the nation to pay for government debt. I hope people enjoyed Kev’s handout because we are going to pay it back many times over during the next decade :)

Ned S
Guest
Pete, Biker, Greg – I think it is pretty obvious how the big picture will unfold. More powers to central banks. More regulation of financial institutions. More taxes. Pete – I found the following well worth a read: http://www.georgesoros.com/articles-essays/entry/the_three_steps_to_financial_reform/ Biker – I think the housing industry and banks will remain protected. But that doesn’t necessarily make negative gearing as we know it sacrosanct. Even more so for future purchases perhaps? Where any mods to negative gearing could just possibly be compensated for in other ways??? I’m just waiting to see what changes these blokes who presumably reckon they have a… Read more »
Biker Pete
Guest
“We know they want tax. We aren’t sure how they are going to get it. ” Ned, 27/9. That’s the dilemma, Ned. The British tabloids are full of it today! There are some fairly wild claims, just the sort of thing that sells papers: taxes on views, verandahs, garages, windows (glazed or double-glazed, with the latter more highly taxed!), larger backyards… the whole gamut! Our present hosts are shaking their heads. If these ploys eventuate, their views, acre-sized backyard, etc., would more than double their annual property taxes. Possibly the largest ‘tax’ we’ve noticed here is parking costs. Some attractions… Read more »
Greg Atkinson
Guest

Biker Sydney is already there regarding parking fees in the CBD. I read an article the other day where Sydney has the dubious honour of having some of the most expensive parking spaces in the world. Have fun in N.Y! A pretty over-rated city in my opinion. I reckon European cities are generally far more interesting.

Biker Pete
Guest
Thanks for the NY comments, Greg. New York is pretty much a means to an end… a four-day gateway to NA we chose this time around. We haven’t seen the east coast of the US, or eastern Canada, before. We expect to find that Quebec may be most affected by the GFC… but then again, every motorcycle we’d have purchased in the province has long since sold! Hired a car for a month, so we’ll see much of the Maritimes, hoping to find a MC in Ottawa. Reluctant to pay $20K+ for a bike we’ll have to flog in January,… Read more »
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