Strap Yourself in

Aussie stocks had a strong day yesterday. The ASX 200 jumped nearly 2%. But it’s likely to give some of that back today. That’s because overnight, US markets opened up strongly, but then started to retreat.

As I write this at 6.30am, the Dow was up 1%, which is probably not enough to keep Aussie stocks in the black today.

Try to ignore the day-to-day volatility though. The chart of the ASX 200 below tells you all you need to know. That is, that the Aussie market is in a downward trend and looking weak.

BUT…and it’s a big but…until it breaks below support (marked by the green line) on the downside, you can’t get too bearish. Stocks could be forming a bottom here.

S&P ASX 200 4-12-18

Source: Optuma

[Click to enlarge]

In my view, the key to being a good investor is not to get too emotionally invested in one outcome or another. You must be flexible. You must be mentally prepared to play whatever game the market presents.

I’ve said previously that I think we could be entering a bear market. But the market doesn’t care what I think. So until there is a break below support, I’ll assume the market hasn’t confirmed my view.

Currently, the market is telling you that there are enough willing buyers (collectively, across all sectors) to hold the index up at an important level. That’s important information for you to know. You may not agree with it, but that’s not the point.

The more of a dispassionate observer you can become of markets, the better investor you’ll be.

And while I’ll patiently wait for the market to provide a more definitive signal, in the meantime, let’s assess the data…

On Friday, the Reserve Bank released an important set of numbers. They didn’t get much airplay. But these are very important numbers when it comes to assessing the health of the Aussie economy.

I’m talking about the monthly release of the credit and money supply statistics. I know, fascinating right?

Total credit growth remained flat at 4.6%. That’s below Australia’s long-term average, but it’s not dire. Importantly, housing credit growth continues to slow. In the year to 31 October, it was 5.1%.

This is the slowest rate of annual growth since 2012/13 when the RBA’s interest rate hikes from the GFC lows started to bite. The only problem is that this time, the RBA hasn’t hiked interest rates at all.

As you probably know, the banks are doing a little credit tightening themselves. Thanks to the prying eyes of the royal commission, they are no longer handing out money to whoever wants it.

They have raised the bar, if only slightly, for those seeking home loan approvals. Doing so has an impact on the demand for credit, which is why it’s been falling this year. Having said that, a 5.1% growth rate, while historically weak, isn’t worthy of panic.

However, growth in the broad money supply is a definite worry. It might not be panic worthy, but it’s certainly worth a discussion.

In the year to 31 October, broad money growth slowed to 1.9%. This is the lowest rate of broad money growth since the early 1990s recession.

What does this mean?

Well, the rate of broad money growth is below the rate of credit growth. In my interpretation, the difference represents paying down of existing debt.

Think about it. We have a monetary system where credit = money, and money = debt. When you take out a loan to buy a house, for example, the bank extends you credit and deposits money in your account. The money goes out into the economy and you have a debt.

When you pay down that debt, it extinguishes the money and therefore reduces the money supply.

After a prolonged housing boom, where the banks provided nearly every decent and half decent client with a loan, people are now focused on paying down that debt. Combined with an attempt to tighten up lending standards, this results in a slowing of the money supply.

That has to have an effect on the economy at some point. Arguably, you’re seeing that effect play out now, as the stock market comes under pressure.

That this is happening with interest rates at historic lows (they haven’t budged in more than two years) is a worry. That this is happening in a very favourable commodity price environment for Australia is an even bigger worry.

Yesterday, the RBA released its commodity price index. Thanks to strong iron ore, LNG, thermal coal and coking coal prices, the index is up nearly 20% in Aussie dollar terms over the past year.

RBA INdex of Commodity Prices 4-12-18

Source: RBA

[Click to enlarge]

Clearly, we are no longer leveraging commodity price gains into the housing boom. While that might be sensible, it is having an impact on house prices, money supply growth, and the stock market and economy as a whole.

It just goes to show how utterly reliant on house price growth our economy has become.

This major growth engine is now in retreat

Which is why the US/China trade situation is so crucial for Australia. Commodity price income gives our foreign creditors comfort that we can service the debt that underpins the housing bubble.

If China weakens, then commodity prices fall and we get an income cut. While the jury is still out on China’s growth, the chart below suggests things may be slowing. It shows the Thomson Reuters CRB Commodity Producers Index, which shows the share price performance of the world’s largest commodity producers.

Thomson Reuters CRB Commodity Equity Index 4-12-18

Source: Optuma

[Click to enlarge]

It’s not a healthy looking chart.

And don’t forget, the US/China trade war is just in a momentary ceasefire. It will resume again soon. News that President Trump has appointed Robert Lighthizer to head up negotiations with China was probably the reason why stocks were off their highs in the US overnight.

The Wall Street Journal has the story…

WASHINGTON—President Trump has named U.S. Trade Representative Robert Lighthizer, a hard-liner on China, to head trade negotiations with Beijing following a weekend summitwith Chinese President Xi Jinping, people familiar with the decision said.

The president informed Mr. Xi of his decision at their Saturday meeting in Buenos Aires, the people said, surprising the Chinese, who have mainly dealt with Treasury Secretary Steven Mnuchin. Beijing had maneuvered for months to deal with Mr. Mnuchin, who is close to financial markets and has been trying to pursue a settlement.

Mr. Lighthizer, on the other hand, has been pressing for more tariffs on China as a way to build leverage over Beijing and has focused on fundamental issues dividing the two nations, such as U.S. allegations that Beijing pressures U.S. companies to turn over technology to Chinese firms and fails to protect U.S. intellectual property.

This trade war is just getting started.

And Australia is right in the middle, at a time when our housing market is bust and interest rates are already at record lows. Oh, and political dysfunction suggests Labor will assume government next year.

So strap yourself in folks, next year is going to get interesting…


Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

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