FYI | Mar 08 2010
FNArena editor Rudi Filapek-Vandyck shares his insights and analyses on a regular basis with paying subscribers via stories labeled 'Rudi's View'. On occasion, one of these stories is shared with non-paying members and with readers elsewhere. This is one such occasion. The story below was originally written and published on Wednesday, 3 March, 2010.
By Rudi Filapek-Vandyck, Editor FNArena
Always tricky to make a prediction on a day when the Australian share market reaches a new five week high (intra-day) and closes higher for the fourth day in a row, but I have a feeling we're on our way to test the levels of early January. If successful, we could see new highs for the year 2010.
Those who have been reading my past analyses know that I keep a close eye on what happens in currency markets. As financial markets continue to be dominated by investor sentiment, what happens between the major currencies has become a key ingredient to determine the direction for financial assets.
That's because all those difficult macro-issues ranging from sovereign debt concerns in Europe, to tightening measures in China and India, to (apparently) less central bank appetite for US Treasuries are instantly translated into changing values between the world's leading currencies.
As such, I believe currency markets have been leading equities and commodities in 2010, and I haven't yet seen a good reason why this would change tomorrow. What has caught my eye is that the USD Index has found it difficult to surge past 81.
There was one quick attempt on the Friday (Oz time) when the Federal Reserve unexpectedly raised the emergency lending costs for US banks, but that didn't even last into the next day. After that we've seen the US dollar rally against the euro, and rally against the British Pound (“Cable”), but the index against the US's five major trading partners has effectively stalled above 80, and below 81.
And one can tell on days when there's only a whisker of the US dollar no longer gaining ground, trigger-ready speculators are overly keen in starting pushing up prices for copper, gold and crude oil, and equities are all too willing to follow in the slipstream.
Note: I am by no means suggesting it's only those evil speculators who are behind February's revival for risk assets. They are simply the first ones to respond and to act. If my information is correct, the present revival among commodities is predominantly the result of funds managers re-entering the space.
It would seem the best case scenario is right now for the USD Index to hold on to its current level, which, in my view, would allow commodities and equities to do what they do best: go higher. If we are talking more bearish scenarios for the US dollar, which are quite frankly more likely if only because FX movements haven't exactly been subtle these past months, then I think we could witness some quick, sharp movements upwards.
After all, and as I have pointed out repeatedly in the past, the first instinct of share markets is to rally higher. So in the absence of anything that keeps a lid on them, that's exactly what share markets will do.
What lies behind future US dollar movements is improving confidence. The same confidence that made the Reserve Bank in Australia announce its fourth cash rate hike in five meetings this week. Do I need to wait until international stockbrokerages such as UBS or Credit Suisse update their Risk Appetite Gauges before I can tell whether global appetite is once again on the rise?
Look around, there's appetite in abundance in March.
The above scenario gains even more credibility since the euro is facing a record number of short positions in the market. Similar to the situation in December last year in the gold market and in January this year with crude oil: when the market is tilted so much into one direction, you can almost bet your money it's going to move into the opposite direction.
In the case of gold and crude oil it was about too many investors being “long”, in the case of the euro right now it's the opposite. (Similarly, the USD is now facing a market which is at record highs “long”).
And while most in the markets, and in the press, have been wetting their enthusiasm on (mostly) Q4 economic data (which are backward-looking since it's already March), I have been waiting for the February update of the IHS Global Insight-USA Today forward looking economic outlook index.
One can probably tell from what I've written so far that the update did not disappoint. In late January the index indicated economic growth in the US had peaked in Q4 and would gradually trend down towards mid-year.
This was one of my major concerns earlier this year: that we would all get excited on the basis of backward-looking data, and simply ignore that global economic growth (US, Europe, China, Australia) was slowing down coming into 2010.
This concern hasn't completely disappeared, but the IHS Global index has improved a lot over the past month. It now indicates monthly GDP growth in the US should remain above 4% for the first four months this year.
Okay, growth is still expected to weaken to 3%- and 2%-plus after that, but at the very least the IHS index indicates the US economy can potentially support global risk appetite until May or June, which is a long time in today's era of short term horizons and impatience.
Thus while the short term prospects for equity markets have improved, the uncertainty of what comes next is not going to go away any time soon. Remember: one of those other leading forward looking indicators -the ECRI index- continues falling, indicating a “dip” in US growth by mid-year.
Note: this index last year correctly indicated the US economy had bottomed and at some point suggested the US would record 6% growth in the final quarter of the year – in light of the latest Q4 GDP growth revision to 5.9% that was pretty accurate on anyone's view.
Assuming most of the above proves correct, and we will witness a new leg up towards index levels last seen in early January, it doesn't really take a genius to figure out what is likely to happen next. This is because, contrary to last year, this year underlying valuations of assets do count, and very much so.
At current index levels in Australia, the share market is trading on a little below 14 times FY11 forecast earnings per share (the multiple for FY10 is much higher). This includes all recent adjustments made after an overall positive reporting season (though not all changes are incorporated yet) and including the recent upward moves in share prices.
But then, once we start approaching those January levels again, we'll be extending the FY11 multiple to 14.5 and beyond – the historical average for the Australian share market one year in advance (not 16 months in advance).
So depending on how fast we're moving, and how much more upside follows in terms of upgrades to forecasts, I'd be inclined to believe we will get to 5000 once again too early and the market will again look expensive.
I don't have to elaborate any more, do I?
I do hope that if we get back to near January index levels, that we will manage to surge higher, even if it is only intra-day or by one point. Hopefully that'll temper all those technical chartists I see every day predicting there's a new bear market waiting around the corner.
If indices make it above January levels, that would take away at least one argument out of the bearish chartists lexicon.
With these thoughts I leave you all, for now.
But not before I share with you one final advice by investment legend Jeremy Grantham, Chairman of the Board of Boston-based Grantham Mayo Van Otterloo, otherwise known as GMO:
“Remember that you will never catch the low. Sensible value-based investors will always sell too early in bubbles and buy too early in busts. But in return, you may make some important extra money on the roundtrip as well as lowering the average risk exposure.
“Life is simple: if you invest too much too soon you will regret it; “How could you have done this with the economy so bad, the market in free fall, and the history books screaming about overruns?” On the other hand, if you invest too little after talking about handsome potential returns and the market rallies, you deserve to be shot.”
P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi On Thursday' (we have yet to update our system). You will receive an email alert every time a new Rudi's View story has been published on the website.
