Trade Links With China Won’t Save Australia This Time


The performance of the Aussie stock market on Friday turned out to be a pretty clear warning. After rallying strongly in the first half an hour of trading, it quickly gave up the gains and finished the day down.

That told you there was a complete unwillingness to hold onto stocks. As I pointed out in Friday’s Daily Reckoning, there is no longer a ‘buy-the-dip’ mentality. It’s all about selling the rallies.

That’s not to say you won’t see a more lasting rally get underway soon. But right now there is just too much selling pressure.

On Friday in the US, stocks had a horror session. The Dow Jones index finished down nearly 400 points. The Aussie market is in for a bad day too. There is real panic in the air. The only positive to come out of Friday’s trade was that the Dow managed to close above the August lows. A break through this level would be very bearish indeed.

At times like this, you’re subject to diverging opinions. The vested interests will tell you there is nothing to worry about. This is just a correction…these things happen all the time. The bears, after years of being ‘wrong’, will tell you this is the start of another global crisis. That this is unfinished business from 2008.

Who to believe?

Well, if you have a bias, I’m sure you’ve already taken a view. Whatever I say isn’t going to change that. But if you’re genuinely confused about what is going on in global markets right now, today’s Daily Reckoning will hopefully provide some guidance on what you should do.

I have a bearish predisposition. So I’m inclined to think this is the start of a rather big bear market, not just a ‘correction’. But I know that I don’t know. I know I can’t possibly assess all the information and make an accurate call about what will happen.

No one can…but it doesn’t stop a lot of opinion flying around…especially from vested interests who want you to ‘keep calm and remain fully invested’.

These pseudo analysts will cite any information that will back their case. You’ll read about economic growth still being healthy in the US, or employment in Australia being strong.

Look, I don’t know much, but I know that this type of analysis is self-serving, not genuine. In today’s markets, in a financialised and debt addicted world, markets drive economic outcomes, not the other way around.

Pointing at economic data to support a bullish market stance has it all back to front. Market’s lead economies. Understand this and you’ll see things in a different light. You’ll learn to understand the difference between PR and real analysis.

For this reason I pay close attention to the markets. That is, I look at the share prices of important companies or indexes of industries to get an idea of what is really going on. Stock prices are the best leading indicator there is. Know how to interpret a stock chart and you’ll be way out in front.

I don’t completely ignore the economic side of things though. Especially when some major big picture stuff is unfolding, like it is now.

Here’s how I see the big picture situation right now. The US economy is doing OK. It’s not particularly good, but it’s not the main worry. Bad debts from the oil price collapse will have an effect on the banking sector, but it won’t be as bad as the sub-prime property blow up.

This is an oil bust playing out, not a land price bust. That means there won’t be as much systemic damage to the US financial system.

The big concern is China. It’s going through a genuine credit bust on par with the global experience of 2008.

From a global perspective, this could bring on a nasty bear market. China is/was a huge source of demand in a low growth world. Its credit-induced slowdown will impact company earnings everywhere and markets will adjust lower to reflect this.

But it’s unlikely to impair the global banking system. China’s debts are mostly held within its borders. That’s a positive. A bear market without a banking system blow up is one the world will recover from reasonably quickly.

This is an ‘aggregate’ view though. We’re in Australia, and Australia is at much greater risk than the ‘rest of the world’. We rode the China boom on the way up, and now we’re about the experience the downdraft.

Keep in mind that we avoided the worst of the 2008 credit crunch because of our trade links with China. While the rest of the world languished, we were in a post-2008 economic boom.

Not only did it boost economic growth, it sent land prices rocketing to extreme levels. Now, Aussie household debt levels are amongst the highest in the world. Our economy is hugely leveraged just as China teeters on the brink.

In my view, China’s credit woes are a huge threat to Australia. China’s bank asset to GDP ratio is around 300%. That compares to around 100% for the US prior to the 2008 crisis. While that sounds extreme, the simple fact is that no one knows how it will play out.

My view is that it will get ugly. But it’s just a view. I want to see evidence that I’m on the right track.

To do so, I use the market. While I monitor a range of companies and indices for subscribers of Crisis & Opportunity, today I’ll reveal one that I think is crucial to the outlook for the Aussie economy.

It’s the financials index, which is mainly the banking sector. The banks, via household borrowing, have benefitted immensely from China. They also benefitted from the commodity bust as this enabled interest rates to fall. But now, the commodity bust is finally working its way into the guts of the Aussie economy. The chart of the financials index proves it.

Source: BigCharts

As you can see, the sector peaked in March/April 2015. Prices then started to fall. The market began to price in tougher conditions.

After plunging in August, the sector then went on to make a series of bottoms around the 6,500 point level. In late December, a strong rally got underway, and it looked like the sector was in recovery mode.

Then 2016 started, and it all came undone. If the index breaks below these lows, it’s telling you the China bust is working its way into the banking system. And that tells you the housing market may have peaked.

If that’s the case, it could get very ugly for Australia in the years ahead.

Greg Canavan,

For The Daily Reckoning

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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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