It was curious that the Australian sharemarket fell yesterday in line with what happened on the US markets. It is curious because the market had become quite disconnected over the past nine months, and the poor economic news that drove the US markets down was very US-centric.

That’s not to say that bad economic news out of the US has no relevance to our market but, if one overlooks the aberration of the March quarter GDP numbers, there’s no comparison between the health of the US economy and the Australian economy.

While investors, globally, are still twitchy and worried about the seemingly intractable problems in Europe, the fragility of the US recovery and the potential for a slowdown in China, it is worth considering whether there might be a more technical explanation, or at least partial explanation, for the apparently direct linkage between Wall Street and Bond Street.

After crashing from their peak in 2007 to their nadir in early 2009, equity markets have bounced back, but some have bounced back more than others.

Until last night, the US market had nearly doubled its lows while the ASX 200 has risen about 45%. Given that both markets fell broadly similar amounts — a bit over 50% — from their 2007 peaks to their 2009 troughs, that difference in performance is also interesting in the light of the stark difference in economic performance, although the non-resource side of the Australian economy is, of course, spluttering.

We, however, look at the Australian sharemarket through a local currency lens. Viewed from the perspective of a US investor, the performance of the Australian market looks quite different.

In the lead-up to the market’s peak in late 2007 an Australian dollar bought about $US85 cents and the dollar kept climbing against the greenback until Lehman Brothers collapsed in September 2008, which triggered a plunge in its value. It steadily recovered ground (or the US dollar steadily weakened) throughout 2009 and 2010 before breaching parity this year.

If one tracks the market (the ASX 200) from its low point in March 2009 in Australian dollar and US dollar terms, the starting point, with the Australian dollar yet to start its surge, it would have looked better to a local investor than for someone who had invested US dollars post-Lehman.

As equity markets started to recover and the Australian dollar began to climb (or the US dollar to fall, or a bit of both) through 2009, however, the market would have looked a lot more rewarding to a US investor than it did for domestic investors — assuming the Americans had invested before the currencies diverged.

As noted, since reaching that low in March 2009 the ASX 200 has rebounded about 45%. From a US dollar perspective, however, (and again assuming the investor had bought before the market turned and the currency relativities altered) the Australian market has returned a remarkable 144 per cent.

Another way of looking at that would be to say that, from the perspective of a pre-recovery US investor who remained invested, there would be a lot of profit tied up in this market that could evaporate if anything – a slowdown in China, perhaps – were to undermine the currency.

Yet another would be to say that from the perspective of a US investor without an existing exposure to this market, it would look quite expensive and there wouldn’t be much of a perceived currency upside, if any.

It is the marginal investor who sets the price of a share, or the level of a market. The appreciation of the Australian dollar against the US dollar and other major currencies would inevitably have deterred some new foreign investment and therefore weakened buying support, which might explain the relative under-performance against the US sharemarket.

Any kind of elevation in levels of uncertainty or concern about the US, global or Australian economy or dollar is also likely to see funds (whether American or from the UK or Europe) that are still sitting on significant currency gains cashing them out and repatriating their funds while they can.

This, is, of course, novel territory as the dollar hasn’t been worth more than the greenback at any previous moment since it was floated in 1983.

It has been well recognised that the strength of the dollar is damaging sectors of the real economy and, if it continues, will force substantial and painful structural change. Less discussed has been the impact on capital flows now that the dollar’s run appears to be over and its value has stabilised at the elevated levels.

If the interest of foreign investors were to wane significantly, it would be significantly more difficult for the sharemarket to break out of the holding pattern it has been in for the past nine months and there could well be more days like today, when a whiff of bad news offshore sent a shudder through the local market.

*This article first appeared at Business Spectator.

Peter Fray

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