The Reason Behind the Aussie Stock Market’s Mixed Signals

stock market graph on big lcd display closeup macro

Stocks didn’t do much in the US overnight. According to the futures market, Aussie stocks will likewise have a non-eventful day. After yesterday’s surge, that’s not surprising.

The ASX 200 closed more than 100 points, or 2%, higher yesterday. The catalyst, apparently, was the ground-breaking news that the Fed thinks the US economy is strong enough for an imminent rate rise but that any subsequent move will come very slowly.

This type of knee-jerk reaction just goes to show you how much computer based trading affects day-to-day prices. It’s widely known that the Fed will only raise interest rates slowly. That’s not news.

But to the computer-based trading systems programed to search for key words, devoid of context, this was a reason to buy. And the herd duly followed.

The resilience of the Aussie stock market is impressive though.

The ASX 200 again bounced off the important 5,000 point level this week. Have a look at the chart below. You can see that 5,000 points has acted as a strong support level since the sell-off in August.

ASX 20Nov15

Source: BigCharts

This level isn’t important just because it’s a round number. There is another reason. 5,000 points represents the half way point between the 2007 high and the 2009 low.

Such points are very significant in all markets. It’s why 5,000 is such an important level of support.

It’s true that support did give way briefly in the late September panic. But strong buying came in almost immediately. From that low point, the market rallied strongly.

Then, it turned down again, falling all the way to…5,000 points. Again, this resulted in strong buying. The market rally so far this week is around 250 points.

This is a positive for investors. It’s why I’m not prepared to get too bearish on this market just yet, even though I think the Aussie economy has all the substance of a bowl of jelly.

Just because you might have a view on the economy or on ‘fundamentals’ in general, you shouldn’t let it cloud your judgement on the market.

This is the way I look at it: The Aussie market is in a downtrend (note the downward sloping moving average lines in the chart above), which is a short term negative. But the strong support at 5,000 is a positive.

This makes me a fence-sitter right now on the overall market. There’s not enough evidence to have a strong view either way. While 5,000 holds, I’m slightly bullish. If 5,000 breaks, and the index closes below this level on a weekly basis, I’ll become much more bearish on stocks overall.

When you drill down, it becomes easier to see why the market is throwing off mixed signals. Let me explain…

As you know, the Aussie stock market is pretty much banks or resources. The long bear market in resource stocks has held the market back. Offsetting this, the long bull market in banking stocks has ensured a respectable overall performance.

But bank stocks peaked earlier this year. The sector came under pressure and at the same time, resources stocks continued to fall. That meant the whole market went down pretty quickly.

Buying support then came in for the banks while resources continued to make new lows. Have a look at this next chart. It shows the performance of Commonwealth Bank [ASX:CBA] a good proxy for the Aussie banking sector.

CBA shares 20Nov15

Source: BigCharts

Now compare it to the performance of the broader market in the first chart. Can you see the similarities?

The banks are holding up the market. It’s the buying of the banks that is behind the strong support at 5,000 points.

This in turn tells me that the commodity price rout is yet to break Australia’s debt dependent economic structure. Whether that will happen is still an open question. I think ongoing falls in the iron ore price will put more pressure on the economy by next year.

But what I think isn’t really important. Right now the performance of banking stocks tells you that things are holding up…that Australia’s debt-soaked economy continues to do ok.

I would be more confident in this view if CBA breaks through the $80 resistance level and holds above there. As you can see, it’s close, but not there yet.

A turn back down in price from here, and a hold above $72 (which seems to coincide with 5,000 on the index) just means the market is not prepared to make a call on the Aussie economy either way. It tells you that things aren’t too bad, but they’re not too good either.

As far as I can tell, that pretty much sums up the situation right now.

What about the future though?

As always, it comes down to China. And I still struggle to see how a nation that went through a massive credit boom comes out unscathed. It’s only doing so at the moment by continuing to take on record amounts of debt, just to repay interest.

As Bloomberg reports:

Chinese borrowers are taking on record amounts of debt to repay interest on their existing obligations, raising the risk of defaults and adding pressure on policy makers to keep financing costs low.

 The amount of loans, bonds and shadow finance arranged to cover interest payments will probably rise 5 percent this year to a record 7.6 trillion yuan ($1.2 trillion), according to Beijing-based Hua Chuang Securities Co. Dubbed “Ponzi finance” by Hyman Minsky, the use of borrowed funds to repay interest was seen by the late U.S. economist as an unsustainable form of credit growth that could precipitate financial crises.

Concerns about ‘Ponzi finance’ are not new in China. While economic growth is strong enough, the Ponzi will flourish. It’s only when nominal economic growth slows to a point that brings on increasing defaults that the whole thing starts to unravel.

Defaults are picking up across China now. But they are still manageable. China’s economy will continue to slow in 2016, meaning you’ll see more defaults.

Whether it will be the inflexion point for China’s credit boom economy remains to be seen. Keep your eye on 5,000 points on the ASX 200 for clues.


Greg Canavan
For The Daily Reckoning

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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