The global market as represented by the MSCI All-Country World Index has soared by 20% since early October last year, signalling the return of the bull market. In the US, the bulls are stampeding back into the market – pushing up the S&P500 index by 23% since early October last year. The Dow Jones Industrial Index hit its highest level since 2008.
Australia, on the other hand, is up a mere 6% in the last six months, based on the S&P/ASX 200 index. It’s a typical example of de-coupling, but in the opposite direction from recent years; during the aftermath of the GFC, the US economy quickly took on water before submerging itself in a sea of debt while the Aussie economy chugged along. With our dinghy firmly latched to the China vessel, we were fairly protected from the global malaise.
So why is the broader Aussie market down 13% this past year? And why aren’t we enjoying the fruits of the latest bull run?
Well, one bull that’s running is the Aussie dollar against the US dollar, the euro, and the pound for that matter. Our unstoppable currency has touched a high of US$1.08 against the US dollar, and traders are now forecasting a return to US$1.10 sometime soon. As reported in the WSJ, David Scutt, senior trader at Arab Bank in Sydney said: ‘We’re heading higher…the currency markets are in a frenzy for Aussie dollars.” BNP Paribas currency strategist Rob Ryan even suggests that the Aussie dollar could eventually track towards the US$1.15 mark, which to us ordinary Aussies seems unfathomable.
There are a couple of reasons for our soaring dollar, which partly explains why the Aussie sharemarket lacks the gusto for serious takeoff. Firstly, there’s the euro carry trade, which has since replaced the yen carry trade as the sure-fire bet for hedge funds seeking fast money. It involves borrowing in euro at around 1% and piling the funds into AAA Australian Government bonds yielding 3%. And since our rates are stickily high (for instance, the RBA held rates on hold this week), and the Europeans are likely to cut theirs to 0.75%, this profitable little strategy is attracting money big time.
A depressed euro helps Europe get back on its feet; a soaring Aussie has the opposite effect on Australia. It hurts our export sector, it pounds our manufacturers, it decimates our tourist and foreign student numbers and it means that consumers and businesses basically prefer to buy or outsource internationally to buying Australian. The unemployment rate is ticking higher courtesy of our dollar’s strength.
There’s another reason why the US dollar, the euro and the pound are weak relative to the Aussie dollar; central banks are driving down interest rates and flooding the world with cash to prop up their economies. The balance sheets of the world’s six largest central banks have more than doubled since 2006 to $13.2 trillion.
The European Central Bank, the US Federal Resource and the Bank of England are hell bent on printing money. There’s so much money sloshing around the system that its finding its way into places like the US sharemarket, hence explaining their latest bull run. Its also finding its way into speculative plays in the Aussie dollar – which is decimating our business sector, and causing our sharemarket to puff and shudder.
Printing money depresses a country’s currency; that’s what happened to the US dollar and the pound, and is currently plaguing the euro. The RBA, in contrast, is keeping rates relatively high – meaning the euro carry trade could in theory propel the Aussie dollar to further heights.
So what’s good about a high Australian dollar? Well, overseas travel is cheaper that’s for sure, and so are big ticket purchases like imported cars, electronic goods and the like. Businesses that use imported materials to sell to the domestic market would be able to buy more stuff for less dollars spent. Savvy investors can pick up international property and shares more cheaply. Always wanted a villa in the south of Italy? Well here’s your chance.
Although the underlying Aussie sharemarket is lacking gusto, there are pockets that are getting a boost from the might of financial speculators betting with newly printed money. Some of our commodity stocks, for example, are enjoying a comeback of sorts as money clamours for hard assets like gold and oil.
In January, renewed fervour for commodities saw money managers boosting allocations to commodity futures and options by 13%, according to the Commodity Futures Trading Commission. Hedge funds raised bullish bets to copper, silver, gold, crude oil, gasoline and even soybeans.
The US Federal Reserve has vowed to keep overnight loans between banks at near zero at least until 2014; the view that low US borrowing costs will stoke inflation is driving investors to buy commodities as a hedge. Between December 2008 and June 2011, commodities have risen by over 80%.
The US is keen to devalue its currency; it supports industry and reduces its interest burden on its unsustainable debt. Basically when the US dollar comes down everything denominated in dollars goes up, and that includes gold, oil and other commodities.
So while the Aussie sharemarket may be under attack from the high Aussie dollar, our mining sector could get a renewed leg up – at least temporarily – courtesy of higher commodity prices.
But there’s a caveat. And that’s China.
China is the wildcard because a slowdown there could send the whole financial chessboard flying. If China slows markedly, commodity prices will be hit, the Aussie dollar will depreciate and our sharemarket could go with it.
Eerily, one of the biggest and most successful hedge funds in the world, Bridgewater Associates, which posted 23% returns in 2011 when the majority of hedge funds blew up, has a couple of big bets on the table for 2012. One is gold. The hedge fund thinks gold’s going up as inflationary pressures rise globally. They’re hardly alone on this one. The fund’s other big bet is the Aussie dollar. But rather than hitching a ride on the euro carry trade, Bridgewater is taking a contrarian stance – betting that the Aussie dollar is heading down, not up, as well betting against other emerging market countries.
There’s a growing movement with the view that China is the wildcard, and the big risk in 2012 sits with China. A recession in Europe will hit demand for China’s products, compounded by a plunging euro – meaning Europeans will buy less imported goods. Container traffic at Shanghai’s port fell 4% in January from a year earlier – with the biggest falls in the Asia-Europe route. The Chinese property market is in freefall.
China’s inflation problem – food prices jumped 10% in January, with some commodities like pork up 25% – is also preventing the government from pump priming the economy.
The IMF warned that China’s projected growth could almost half if Europe, its largest trading partner, continues to falter. The World Bank pipes in with a dire warning for developing nations in 2012. While the IMF and World Bank have clear agendas of their own for saying such things, sentiment shifts caused by global news media hype are still worth watching.
There’s growing interest in shorting equity markets in the BRICs (Brazil, Russia, India and China) as well as natural resource stocks hooked on China demand, and that’s where Aussie stocks come into the firing line. While in previous years, our closeness to China was our rallying cry for markets to advance higher – today it could partly explain why our ticket to the global bull party is not forthcoming.