Sometime around last Thursday afternoon the mood in the market went from concerned to “totally freaked out”. It is a trifecta of concerns that have investors on the edge. Chinese growth is slowing. The American employment picture is not good. And Europe is in the middle of a dangerous debt crisis.
The result for Aussie stocks was a $25 billion wipe-out on Friday. Stocks made a three month low and fell by 2.3%. Aussie stocks are now 45% above their March lows. But the direction from here is anything but clear.
As cautious (and bearish) as we generally are, this could actually be a very good buying opportunity if you’re a fearless trader. It felt this way in markets in December of 2008. There was a real sense of despair at the time. And at the time, we talked with Kris Sayce about whether or not to recommend any stocks that month in his newsletter.
The conclusion then was what we try do every month: give you our best idea. Kris’ best idea at the time was to take a punt on some LNG stocks. As it turned out, it worked really well. The stocks were cheap and the point of maximum despair was a great entry point.
Does today present you with the same kind of entry point? Well that depends on if you think we’ve reached a bottom in bearish sentiment. A few weeks ago the Investor’s Intelligence survey had the fewest number of bears in twenty years and the most bulls since the market top in 2007.
Then, within the space of a few weeks, the percentage of self-identified bulls slipped from 53% of those surveyed to 38.9%. The bull-to-bear ratio also declined from 3.36 to 1.75. Not that we have much skill at reading charts, but you can see from the chart below that the bull-to-bear ratio has had trouble getting and staying above 3.3 over the last three years.
If you were using investor sentiment as your timing mechanism to enter a long trade now, you might want to wait until a further decline in the bull-to-bear ratio. We’ll duck into the research office later today and ask Murray what that might correspond to on the ASX/200. That said, he’s just sent through a new “buy” alert via the Slipstream Trader on a stock he thinks is already over sold, so the timing of the trades may vary based on the business and the industry.
By that we mean the news in the banking and resource sectors may also be as big a driver of stock prices as sentiment. On the resource front, a stronger U.S. dollar means falling commodity prices. More importantly, there is the argument than China will dial back growth to restrain inflation.
Charles Dumas from Lombard Street Research writes that, “With China overheating and soon to repress its domestic demand, India ditto in the the throes of major inflation, and the commodity countries about to be caught in a collapse of their metal and energy export revenues, the second leg down of the ‘W’ could start by 2010 Q3.”
That’s obviously not a very bullish forecast for resource shares. He’s arguing that this move in the share markets presages a bigger fall in the global economy. If that argument is correct, you’d expect bigger falls in commodity prices and commodity stocks and a weaker Aussie dollar.
Mind you, none of these seems to have bothered the markets much at today’s opening. Stocks are up. And over the weekend Clive Palmer announced that his private firm Resourcehouse had signed a $70 billion deal to export coal for twenty years from Queensland to China. That’s going to be a lot of coal.
It’s estimated to be about 30 million tonnes a year, to be precise. China Power International Development will contribute US$5.6 billion in debt financing to build four underground and two surface coal mines in Queensland. Hmmn.
This not-so-little development suggests that even with tighter monetary policy, Chinese per-capita energy use is rising from a very low base. That means there could be much more growth ahead in Chinese energy imports, even if industrial production slows down.
That argument seems riddled with internal contradictions, of course. China will use less energy if China makes less stuff to send to consumers in the West. But if Chinese wage growth appreciates – which could also be accomplished without inflation by allowing the currency to strengthen – there might be more internal demand. Or, China might buy more of the stuff that it makes, which would hold up demand for resources.
None of that might matter much in the next few months if financial markets have another nervous breakdown. And what about the other major driver of Aussie indexes, the banks? A lot depends on how the market takes the news that the Federal government is withdrawing its guarantee on large deposits and wholesale funding for the banks.
The guarantee won’t go away until March 31st. The government is convinced that the economy is strong enough now that banks can raise wholesale funds without its backing. Whether the banks choose to raise that money, or raise interest rates on consumers too, remains to be seen.
One big issue to watch: credit growth. If the banks feel adequately capitalised, are confident about the performance of their loan portfolios, and not worried about raising money from abroad, credit growth should resume and the economy would hum along. If banks tighten up, watch out.
Watch out is probably good advice in general at the moment. In 2008, the business model for investment banks broke. Leveraged players imploded in the credit crisis. Since then, the risks taken on by the financial system have been transferred to national governments. The result is higher annual deficits and larger debt-to-GDP ratios and a general concern that the deficits may never be paid back.
Last week, Moody’s said as much. Specifically, it said U.S. economic growth would have to be much higher than projected for the country to grow its way out of its debts, which are themselves growing pretty fast. If America can’t get its fiscal act together, Moody’s said the triple A credit rating enjoyed by Uncle Sam is at risk.
“Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in the projections for the next decade will at some point put pressure on the triple A government bond rating.” This year’s $1.56 trillion budget deficit is 10.6% of GDP. And overall, when you include household debt, corporate debt, and state and local government debt, the ratio is well on its way to 100%.”
Strange that despite all that the greenback is rallying. But as we said last week, we’ve seen it before. In a risk averse world, liquidity matters more than yield. That said, this year’s permutation of the Global Financial Crisis is different. The problem with national governments in fiscal crisis is that there is no one to bail them out. This is what makes debt default for at least one of the struggling European nations so likely.
For America? Technically, a nation that can print the money in which its debts are denominated cannot default. It can always print more money (inflate) to pay off creditors. Practically, creditors know this too and plan ahead of time. First, they shift to shorter durations in their security purchases (which they have done). And they diversify into other currencies or hard assets, which they also have done.
Where does that leave us on a Monday? We’re at the pointy edge of what feels like another financial panic. The trader with a pocketful of courage might double down on the negative sentiment and buy some oversold stocks for a rebound. And the investor?
At best, we reckon the markets will remain range bound with so much uncertainty coming from fiscal and monetary policy. The world’s major economies are not exactly transmitting clear intentions either. And Australia, whose economic success derives from the economy in China and global capital flows, is caught in the middle of all of this. More tomorrow on what to expect.
for The Daily Reckoning Australia