The Monday Report

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By Greg Peel

Would the last foreign investor to leave the Australian stock market please turn out the lights.

Following the recent cut, the RBA cash rate is at 2.75%. The Fed funds rate is zero, but when QE is taken into account, NAB economists calculate an effective rate of minus 6%. Even at their absolute peak, Australia’s big banks were still yielding around 6%. It’s not hard to see why US investors, for one, have found the Australian stock market a valuable place to invest.

Foreign investors who entered the Australian stock market last year have done extremely well. Stock prices, particularly those of the banks for example, rallied strongly, yet the Aussie held up well over parity with the greenback despite ongoing RBA rate cuts. The exchange rate held up because despite RBA easing, the interest rate differential to the US and other major foreign centres remained substantial.

Last week, the tide turned. The tide had already begun to ebb on weakening Chinese data, which threatened Australia’s mining export revenues as commodity prices fell further than they already had. But the real gravitational pull has come from the Fed. Whether or not one believes the Fed is about to start tapering off QE so soon or not, the threat has been made. Reduced QE effectively means a rise in the Fed funds rate, even though there’s still a long way back to “actual” zero, let alone cash rate parity. That threat has helped tipped the Aussie over the edge and down through exchange rate parity.

If Australian stock prices remain supported, but the Aussie falls, foreign investors lose money on the exchange rate. Alongside talk of Fed tightening there has been much talk of the Aussie now correcting, backed up by major broking houses downgrading their currency forecasts. Foreign investors have made a lot of money out of the Australian stock market. Time to take profits.

Last week the trickle turned to a flood. Market commentators were surprised with the severity of the fall on Thursday, called a bounce for Friday, and got that terribly wrong too. What we are seeing is not just a building exodus, but a negative feedback loop. Every profit taken on Aussie stocks and converted back to US dollars incrementally pushes the Aussie down. The more the Aussie falls, the more foreign investors are “hurried up” to get out. The more they get out, the more the Aussie falls…

Should Australian investors be upset? Well it depends if you’re in, or still out. And if you’re in, whether you’ve been in for some time or finally decided to jump in in April. If you were late to the rally, you will not be too happy. If you were early to the rally, you may have missed a short term trading opportunity. If you’re a longer term investor, these are the ebbs and flows of longer term investment. If you’re still in cash, you should be smiling.

A popular stock market expression is “don’t try to catch a falling knife”. The great foreign exodus is bringing stock values back to levels which will no longer have stock analysts scratching their heads as to whether they can still put yield-based Buy ratings on stocks which are otherwise clearly overvalued. The banks are a particular case in point. At some point the dust will settle and rising entry yields (on falling stock prices) will entice investors in again. A less overvalued Aussie dollar will alleviate the pressure on Australian export industries. The stock market will find a more realistic value. Then it’s just a matter of wondering, when the Fed actually does start to taper off its bond purchases, whether Wall Street will fall out of bed and take global stock markets with it.

The pattern of trade on Friday night on Wall Street was identical to Thursday night’s pattern. The indices traded down from the open, equivalent to 95 Dow points, then spent the rest of the session rallying back to the flatline. By the closing bell, the Dow was up 8 points, the S&P was down less than a point to 1649 and the Nasdaq was flat. US investors remain keen to buy any dip. Either they refuse to believe the Fed will have scope to begin tapering this year, or they don’t care.

The US data point for the day was new durable goods orders, which rose 3.3% in April compared to expectations of 1.4%. Take out lumpy military and aircraft orders, and the underlying result was a rise of 1.3%. Earlier in Europe, the German IFO business sentiment survey showed a gain to a better than expected 105.7 from 104.4 in April.

After a week of swings and roundabouts, the US dollar index ended only slightly down at 83.65. The Aussie also had a wild week, and Friday’s ongoing foreign exit helped the currency down another half a cent to US$0.9651. Gold is trying hard to consolidate in an uncertain world, and it fell US$6.20 to US$1385.20/oz.

Base metal prices moved in both directions on Friday, but not materially. Copper rose 0.3%. Brent crude rose US20c to US$102.64/bbl and West Texas fell US34c to US$93.91/bbl. Spot iron ore is unchanged at US$123.20/t.

The SPI Overnight fell 6 points.

The Japanese stock market has now corrected for the time being. The German stock market has pulled back from all-time highs. The Australian market is being de-rated back below levels many considered overvalued. It is only the US market that is refusing to budge, despite the US central bank being the primary source of recent global volatility.

As we look to the week ahead, we find ourselves in the unusual situation of first making note of any more “Fed-speak” in the offing, for it is the public ruminations of Fed officials over the last couple of weeks that have sparked all this uncertainty. Sure enough, the Boston Fed president and FOMC member will speak on Wednesday, as will former Fed chairman Paul Volker, while the Cleveland Fed president, non-FOMC, will speak on Friday along with a non-voting member of the board of governors. Chairman Bernanke will speak on Sunday.

Wall Street will first enjoy a long weekend break on Monday, for Memorial Day, which heralds the beginning of summer. On Tuesday, the Case-Shiller house price index will be released along with the Conference Board consumer confidence measure and the Richmond Fed manufacturing index. Thursday it’s pending home sales and the first revision of the US March quarter GDP, for which no change is expected. Friday it’s the Chicago PMI along with personal income and spending and the Michigan Uni fortnightly measure of consumer sentiment.

China will report industrial profits today and its official May manufacturing PMI on Sunday. Japan will report retail sales on Wednesday and inflation, industrial production, manufacturing and employment data on Friday. India will report its March quarter GDP on Friday.

Australia is now counting down to its own March quarter GDP result next week. This week we’ll see March quarter construction work done on Wednesday and private sector capital expenditure on Thursday. Capex is at this time arguably the most important GDP component and forward indicator. Resource sector spending and spending intentions are captured in this result, which will provide further evidence of the peak in investment. Thursday also sees monthly building approvals and Friday private sector credit.

On the local stock front, ALS ((ALQ)) will report its full-year result today, while Programmed Maintenance ((PRG)) will provide its full-year and Aristocrat Leisure ((ALL)) its half-year on Wednesday. David Jones ((DJS)) will announce March quarter sales today, investor days will be held by Suncorp ((SUN)) tomorrow, Wesfarmers ((WES)) on Wednesday and Sims Metal Management ((SGM)) on Thursday.  National Bank ((NAB)) will also go ex-dividend on Thursday.

Rudi will appear on Sky Business today at 11.15am, Wednesday at 5.30pm and Thursday at noon, and on BRR Media on Friday at 1pm.
 

For further global economic release dates and local company events please refer to the FNArena Calendar.

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