The Australian Stock Market Finally Did It – Champagne and Valium

Pop the champagne everyone (or a valium, if you’re a bear) the Australian stock market finally did it!

Yesterday, the ASX 200 closed at a new, all-time high of 6,845.1 points, up 0.3% on the day.

Don’t celebrate (or commiserate) too hard though. The air is proving a bit thin up there. Stocks are expected to retreat today. The Financial Review reports…

Australian shares are poised to drop at the open amid renewed angst about the trade dispute between the US and China.

ASX futures down 30 points or 0.4% to 6753 near 6am AEST. The currency slid 0.4 per cent.

On Wall Street, all three benchmarks ended modestly lower, with both trade and the pending US Federal Reserve policy decision pending.

President Donald Trump warned China against waiting out his first term to finalise any trade deal, saying if he wins re-election in the November 2020 US presidential contest, the outcome could be no agreement or a worse one.

“The problem with them waiting…is that if & when I win, the deal that they get will be much tougher than what we are negotiating now…or no deal at all,” Trump said in a post on Twitter.

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It’s worth noting the main driver of this year’s stock market melt up: large-cap stocks. The chart below shows the ASX 50 (the 50 largest stocks in the index).

It punched through the 2007 high early this month…

S&P/ASX 50 - XFL - 1 Day line Chart - AUD - 31-07-19

Source: Optuma

[Click to open in a new window]

In my view, the large, dividend paying stocks have now become bond proxies. Thanks to the RBA slashing interest rates, investors are looking for income and will pay higher and higher prices to get it, regardless of the risk.

As long as earnings hold up and don’t threaten the dividend payments, then the price rise is justified.

But we know earnings are cyclical and go through ups and downs. So there will come a time when the collective mood of the market shifts from bullish to bearish. We just don’t know when that time will come.

Look at Telstra Corp Ltd [ASX:TLS] for an example of the bond proxy. Its share price broke out to a two-year high yesterday. If anything, Telstra is still under earnings pressure after years of downgrades and dividend cuts.

Telstra Corp Ltd - TLS (ASX) - 1 Day line Chart - AUD - 31-07-19

Source: Optuma

[Click to open in a new window]

But the market is now getting more comfortable that the worst is over. This means it can go back to treating Telstra like a bond proxy. And as investors search for yield, ‘bond’ prices go up, and yields decline.

So it’s the large-caps leading the charge.

 

But if you have a look at the ASX 300 below, you’ll see that it’s lagging the bigger stocks. It’s yet to beat the highs from 2007.

S&P/ASX 300 - XKO (ASX) - 1 Day line Chart - AUD - 31-07-19

Source: Optuma

[Click to open in a new window]

That’s because the small-caps aren’t doing as well. As you can see in this next chart, the Small Ordinaries index has only just broken through its highs from early 2011. It’s nowhere near the 2007 peak.

S&P/ASX Small Ordinaries - KSO (ASX) - 1 Day line Chart - AUD - 31-07-19

Source: Optuma

[Click to open in a new window]

What to make of all this?

Well, the credit boom that led to the 2007 stock market peak was a genuine boom, underpinned by solid economic expansion.

China’s industrialisation was just getting started. It produced a genuine boom for Aussie commodities. That in turn led to massive share price gains for small-cap resource stocks and related mining services companies.

This time around though, the boom is nearly all down to central banks. Economic growth is below average given the debt burden the economy now carries.

Central banks are trying to ease that burden by lowering interest rates, but that is leading to more and more asset market speculation.

The correct way to ease the burden of too much debt is to let it go bad and write it off. That involves some short-term pain. But it ensures longer-term stability.

Of course, we are well past that point now. Creditors will be protected at all costs.

How all this turns out is anyone’s guess. Some argue for an epic bust. From a moralistic point of view, that makes sense. But keep in mind deflationary busts means the value of fiat currency increases relative to stocks and real assets.

That seems unlikely. Central bankers won’t give up the path they are on until they have completely destroyed their currency values against real assets.

So while I certainly think we could be in for a big correction, I don’t subscribe to the deflationary bust theory. Rather, ongoing asset inflation will be the overall trend.

Which means, in my humble view, you should have a precious metals strategy for your portfolio. You can check out my report, here, for starters.

Also, you can register for the Gold and Alternative Investments Conference being held in Sydney this year on October 24–26. Our good friend, Kerry Stevenson puts this conference on each year. It’s a cracker.

It’s a chance to listen to a great bunch of keynote speakers (including Daily Reckoning Editor, Shae Russell) as well as hear from a range of precious metals companies.

Getting back to the market, and while short-term sentiment is undoubtedly bullish, I’m conscious that all the good news is priced in for now. That might be reason to kick off a round of profit taking, and bring about a much-needed correction.

Regards,

Greg Canavan,
Editor, The Rum Rebellion

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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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