One Way to Decipher What the Market is Saying

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It’s looking pretty grim, isn’t it?

Overnight, the Greeks and their creditors failed to reach agreement yet again. But don’t worry, there’s another deadline to look forward to. This time it’s Saturday!

From the Financial Times:

EU leaders, having tripped over multiple deadlines for Greece to accept a reform plan to unlock €7.2bn in bailout aid, set Saturday as Athens’ last chance to strike a deal or trigger a “plan B” that would attempt to prevent a Greek default from damaging the rest of the eurozone.’

But Saturday’s meeting already looks futile, judging from the article…

…multiple officials said there was no chance of creditors accepting the new Greek proposal and that they were readying plans to “ring fence” Greece so any economic upheaval unleashed by a default would not spread. Those plans are believed to include capital controls and even humanitarian aid.

The bleakness of the situation was underlined during the finance ministers’ meeting on Thursday when a handful of participants, led by Wolfgang Schäuble, the German finance minister, told colleagues they believed the creditors’ compromise plan was too lenient, leaving no more room for concessions to Athens.

“There is no convergence, there is absolutely no convergence,” said one senior eurozone official. “It is looking bleak.”

It’s looked bleak before though.

For all the words written about potential Greek default, the reality is no one knows what the outcome will be. Greece could default this weekend, or this thing could drag on for months, or even years.

The best insight you can get is to see what the market thinks. After all, ‘the market’ is just the combined investment and trading decision of every participant in the market.

It’s not the opinion of journalists or the newspaper editors who have no money on the line. That’s why the market’s opinion is so forceful. It’s ‘the money’ talking.

So let’s have a look at a chart of the Aussie market to see what message it’s trying to communicate. I asked Jason McIntosh to do the deciphering. Jason is the brains behind our highly successful Quant Trader advisory service.

Quant Trader is unique to the Australian retail market in that it uses algorithms to generate buy and sell signals. That is, it doesn’t muck around with personal opinion. It uses the only opinion that counts, that of the market, to sniff out trading ideas.

And since its launch last November, it’s had rave reviews from subscribers. It’s been our most successful trading product by far.

One of its great strengths is to scour the market (all 2000 stocks) and find future stock market stars. Through extensive and rigorous back-testing, Jason shows how Quant Trader picks out stocks ‘before they were famous’. You can read more about it here.

So what is the market saying? I’ll hand you over to Jason for a comprehensive explanation. It’s not just about what’s happening right now (as ugly as it is!)

On the surface, the All Ordinaries (see chart below) is starting to look ugly. It’s now just 2.4% above where it began the year. And I expect this figure to dwindle further in the coming weeks.

But you need to look beyond the last few months. You have to put the recent price action in context with the bigger picture.

The key to markets is identifying the underlying trend. It always amazes me how many people don’t do this. Instead, they base their views on the immediate past.

This is an emotional way to trade. And it leads to people exiting the market at the wrong time.

You see, markets move in large trends. And the overall trend in the All Ordinaries remains up. It’s been this way since 2009.

Now it hasn’t all been smooth sailing. There have been plenty of corrections along the way.

But each time, the dominant trend has gone on to new highs. I expect this time will be no different.

Think of it like breathing. No one just keeps on inhaling. You have to breathe out as well. Markets are the same. They have to correct from time-to-time.

There are two key strategies to doing well in this type of environment:

  1. Use a stop loss. You need to exit positions that fall too far.
  2. Only buy into strength. Resist the urge to try picking a stock’s low.

It’s about cutting what’s not working…and getting into what is.

All trends inevitably end. But it’s too early to rule off on the bull market in Aussie stocks.

The big picture trend is your best guide to what’s going on. And right now, that trend is still intact. It’s been this way for a number of years.

Always remember this. Probability is on the side of the overriding trend.

***

At least all this focus on Greece is keeping the spotlight off the problems faced by Australia right now. The iron ore price is back down below US$60 a tonne and set to head much lower. That’s problem number one.

Problem number two is that our next great export hope, LNG, is looking shaky too. That is, there is increasing concerns about the demand outlook for all the LNG we’re about the flood the market with.

After investing tens of billions in new LNG capacity, Australia now runs the risk of achieving sub-standard (wealth destroying) returns on that investment. As the Financial Review reports:

While there’s no evidence that any contract will be reneged upon, talk has emerged in recent weeks of efforts afoot to have terms modified in ways that would have been unthinkable in the past.

At the root of the problem is the wide gap that has opened between spot and contract prices for LNG in Asia, which combines with other factors to suggest we are entering new territory. Spot prices that were trading up to a third higher than contract prices in early 2014 are well below now and are expected by many to remain so for the rest of the decade.

At the same time as our largest immediate and potential export earners come under immense pressure, household debt levels are at record highs. Check out this chart from Kieran Davies at Barclays:

It shows household debt to nominal GDP at a record 130%. As you can see, over the past few years Australian’s have increased their debt load while the rest of the world has reduced theirs.

You can put that latest uptick down to the RBA’s 2011–2013 rate cutting cycle, which continued in 2015. Falling interest rates equals more debt equals rising house prices, which equals the need for more debt.

The only conclusion you can draw from this is that Australia is completely ill prepared for the next global downturn.

But like Greece, no one knows when the cycle will turn. For clues, keep your eye on the market. Or keep your eye on Quant Trader. Based on back-testing, during the last major downturn in 2008, Quant Trader’s algorithms shifted from ‘long’ to ‘short’ recommendations, meaning after an initial dip, it profited handsomely from the falling market.

Quant Trader is like a market pulse. If it’s not picking up buy signals and starting to increase the sell signals, you’ll know that market momentum is starting to turn.

Read on below for an essay on personal experiences and lessons learned from Jason McIntosh.

Regards,

Greg Canavan+,
For The Daily Reckoning, Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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John Hutchinson
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I think Greece would be better served to sell naming rights to some of its big ticket attractions. The “Apple Acropolis” and the “Coca Cola Parthenon” have a certain “ring” to them and on 10 year Deals at $10mil/annum would see them clearing the debt in no time.

Better than accepting any deal from Politicians and European Bankers, I’m guessing.

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