Aussie stocks took a thumping yesterday. The ASX200 finished the day down 80 points, or 1.5%. There was no local news to spark the sell-off. The Aussie market just followed its North American cousins lower. That’s probably because the cousins were doing much of the selling.
There’s a lot of foreign capital in Aussie equity markets. When they want to sell, it will drive prices down. That’s probably accentuated by the fact that most people in the Aussie funds management industry are down at the beach. Or more likely frying at the beach if they’re anywhere along the coast of Victoria or South Australia. It’s damn hot down here!
But yesterday’s market sell-off could be short lived…the bulls are back! US markets surged (again) overnight, apparently on better than expected retail sales. But we think you should be careful in how you interpret the move.
The retail sales data was better than expected. That’s not to say it was great, but expectations mean a lot. We’re in a traders market, where short term speculators position themselves for every data release. They position their trades based on certain expectations. The non-farm payrolls data release is a major one. That’s why markets tend to go berserk around the time of that release.
Retail sales data draws a lot of attention from traders, too. Last night, most were positioned for a poor outcome, and when it came in ‘better than expected’, many were caught wrong-footed and had to get out. This probably led to a lot of short-covering, which is why the market surged.
So nothing to see here folks. It’s a traders market and with the QE ‘taper’ about to begin, there’s less support from the Federal Reserve as we kick off 2014, which means each major data release will come with a decent amount of volatility as the punters look to profit from something other than the Fed.
There’s not much going on in Australia right now, apart from unrelenting heat, so we’ll take a look around the region to see what’s happening.
Yesterday, Japan reported its largest current account deficit ever for the month of November, as a weaker yen failed to increase exports. The trade deficit was 1.25 trillion yen, offset by an income surplus (which is the net income Japan earns from its vast foreign assets) of 900 billion yen.
This sort of data is no big deal for market punters and probably didn’t have much to do with the Nikkei’s 3% plus fall yesterday. But it has major long term implications as it points to big structural changes occurring in the global economy.
Japan’s post Second World War economy was an export powerhouse. That meant constant trade surpluses…which Japan ploughed into foreign assets and US treasuries, assets which now generate an income.
But now Japan has turned into a net importer of goods and services. If the weaker yen doesn’t boost demand for Japan’s exports – and it’s not doing so yet – then the deficits will increase. That’s because Japan imports necessities like food and energy. A weaker yen makes these necessities more expensive.
What’s more, Japan’s ageing society will feel the impact of these prices rises and slowly run down their savings to pay for them. From a bigger picture perspective, this means in years to come Japan will need to start selling off its foreign assets to maintain its domestic standard of living.
Such a change will have profound implications for the structure of the global economy. It represents a change from Japan being a net producer to a net consumer. That means someone on the other side of the equation must change from being a net consumer to a net producer.
Of course, it doesn’t have to be one country. It can be a combination of countries. But if you throw a China rebalancing into the mix (which means they’re trying to consume more and produce less on a net basis) it means the world’s largest consumer, the US, will need to start consuming less and producing more. It also means the other great Anglo consumer nations like the UK and Australia will need to pull their heads in on the consumption front.
But guess what, in the US it’s already happening! In today’s Financial Review, global capital flows guru Barry Eichengreen writes that ‘The age of imbalances has ended‘. He points out that the US current account deficit is now just 2.7% of GDP, down from an ‘alarming’ 5.8% in 2006.
He reckons only two countries stand out now. Germany, with a current account surplus of 6% of GDP, and Turkey, with a hefty 7.4% deficit. Australia, we should add, is not travelling too well with a deficit of around 4.7%. It’s a good thing we had the commodity boom…
Eichengreen is clearly happy about the diminishing global imbalance situation and he is certainly right that capital and trade flows are adjusting for the better. As a result, he thinks the accumulation of US dollar reserves is about to peak:
‘…the accumulation of foreign reserves by emerging and developing countries – another phenomenon over which much ink has been spilled – may be about to peak. Then it will be just another problem laid to rest.‘
A problem laid to rest? Let’s see. Foreigners no longer buying US assets mean US interest rates will rise. That’s already happening throughout 2013, even as the Fed bought up around US$500 billion. If the Fed goes ahead with the taper and no longer supports the Treasury market, interest rates will rise further.
That will put pressure on US government finances, as its annual interest bill is now approaching US$500 billion per year. With higher interest rates that will rise quickly.
Higher interest rates in a world with a very heavy debt burden will impact on economic growth. That in turn will see stock markets under pressure. So depending on your perspective, the laying of one problem to rest will just mean the hatching of more problems.
But’s that’s not unusual. Financial markets always face problems. The question investors (not speculators) must ask themselves is whether or not the risks posed by the problems are factored into stock prices. In other words, are you getting adequate reward for the risk you’re taking?
In our view, in today’s market it’s all risk for little reward.
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