The Australian market has shown amazing strength in recent weeks, almost belligerent to the negative economic sentiments echoing from the US.
Last month’s correction seems like a distant memory, with the market closing last Friday at 6278, having risen from a low of 5700 less than a month ago. That is one very volatile market.
Uninterested onlookers would be forgiven for thinking that a spate of good economic results was behind the recent buying spree. However, if anything, raw economic data emanating from the US is actually worse now than it was during the August correction. Data indicates that the US property markets looks like it is about to drop even further.
The Wall Street Journal reported on Friday that “a record number of homes entered the foreclosure process in the second quarter [with] 5.12% of all loans were past due, or delinquent, on a seasonally adjusted basis, compared with 4.84% that were past due at the end of the first quarter. The MBA’s delinquency statistics do not include loans that are already in the foreclosure process.”
Property is a key leading indicator of economic activity, largely because a falling property market has numerous negative effects on economic growth. First, when the property market falls consumer sentiment is hit. This leads to weakening economic growth (consumer spending generally makes up 70 percent of GDP) and lower company profits. Second, reduced property values quite simply mean there is less wealth upon which investment can occur. It’s hard to take a “line of credit” on your home to buy shares or another property when you have negative equity.
Recent jobs data has also been bleak, with the US Department of Labour announcing that US employers shed 4,000 jobs in July, compared with a forecast creation of 110,000 roles.
The other bogey, which could have an even more devastating effect, but which has managed to escape wide-spread attention is the slowly rising oil price. Last week, oil hit US$77.43 a barrel, only just below the record high of US$78.77. Oil prices act as a nasty external shock to economic growth and inflation.
A slowing economy and a rising oil price can lead to stagflation, the most evil of economic conditions. It is therefore not unfeasible to think that the US could have inflation, coupled with a growth slump, effectively restricting the ability of the Fed to stimulate demand by increasing money supply.
Throw in a crippled private equity market and you have some very overvalued equities.
Rarely has Ben Graham’s Mr Market allegory about the stock market rung so true as in the past six weeks. As Graham noted:
For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Last month Mr Market was on the verge of taking his own life. This month, despite every reason for him to be depressed, his mood changed markedly after his GP, Dr Bernanke, prescribed him with a dose of medication.
Unfortunately, the medication will only help the symptoms of the sickness and not the underlying cause. And too much medication might make the problem a lot worse.
Disclosure: The writer has a “short” position on the ASX200.