I don’t know what happened yesterday, but it was an ugly day for stocks. The ASX 200 finished 70 points, or 1.26% lower.
You can’t really put the big move down to the looming Greek default either. In my view, it’s investors waking up to the fact that the local economy is extremely weak, with no real catalysts for an improvement anytime soon.
But we should get a little reprieve today. US market’s had a good session overnight, with the NASDAQ index hitting a new record high. It’s taken its time though. The old record stood since 10 March 2000.
So for punters who bought at the dot com peak, it’s been a long wait to get back to their starting point. Stocks for the long run indeed.
While European markets are understandably nervous, US stocks certainly don’t care about the turmoil in Greece. European stocks had a late rally on hopes of yet another rabbit coming out of the hat for Greece, but this time, it just doesn’t look like it’s happening.
There’s an air of inevitability about Greece defaulting. The ‘bail-out’ is an unequivocal failure. According to the Financial Times, the unemployment rate for Greece’s under-25s is 40%, double the European average. That is a national tragedy. Idle and disaffected youth is what sows the seeds of turmoil and revolution.
The Financial Times reports that
‘As with other crisis-hit parts of Europe, the young have been forced to endure the indignity of living at home and relying on handouts from their parents, delaying plans for marriage or emigrating to find even menial work.’
Errr…don’t come to Australia then! Kids here live at home for longer too and rely on handouts from their parents in order to get into the property Ponzi. I’m not sure they suffer from indignity though! There suffering is perhaps yet to come.
Central banks and government policy are destroying social systems around the world, they’re just doing it in different ways.
In Yesterday’s Daily Reckoning, I pointed out how central banks were trapped in a dilemma of their own creation. Prolonged low interest rate policies have unwittingly lowered the economy’s ‘natural rate of interest’, meaning low official rates aren’t as attractive as they seem.
And in today’s Financial Review, there’s evidence of this happening:
‘Ninety per cent of Australian firms won’t embark on investment if the expected return is less than 10 per cent according to new Reserve Bank of Australia research highlighting the growing divide over why low official interest rates aren’t spurring an economic recovery.
‘With corporate Australia challenging Reserve Bank governor Glenn Stevens’ claim that their refusal to invest is holding back Australia’s economic growth, a survey of firms showed executives and directors are more worried about high costs, taxes and weak demand than the cost of capital.’
Despite official rates sitting at just 2%, businesses can’t borrow at anywhere near this rate. And if their ‘hurdle’ for making an investment is a return of 10%, and that doesn’t look achievable, then businesses won’t borrow.
It’s a different story for borrowing against residential property though. Property investors (rather than owner-occupiers) are behind the borrowing and price surge in the prime markets of Sydney and Melbourne.
Interest rates for property investors are much lower than for businesses and these investors still see strong gains ahead for the major property markets. These strong perceived gains justify the big pick up in borrowing.
In other words, the natural rate of interest in the property market (the natural rate being the return on incremental capital investment) is still above the borrowing rate.
But as each additional investment dollar chases these returns, it lowers the natural rate. At some point (and that point is getting close) the natural rate will fall below the borrowing rate, and lending will fall sharply. It’s just how economics and markets work.
It will be interesting to see the market’s response to all this. Yesterday I mentioned that Australia hadn’t yet experienced its GFC moment. What I meant is that we haven’t yet experienced any economic hardship like our friends in the northern hemisphere.
At the time of the crisis in 2008, we had a government with the capacity to spend, a central bank with the capacity to cut interest rates, and our biggest trading partner with the capacity to ignite a credit boom.
All those things helped the Aussie economy immensely…especially China’s credit boom. Seven years later, household and government debt levels are considerably higher.
Now, with our economy slowing, we have none of the above to help out in the event of another global shock, or just ongoing economic weakness.
That’s not to say nothing can be done if need be. The RBA could lower rates further…and the government could increase its budget deficit and blow out its debt ratio.
Doing this would smash the currency, and a big enough fall in the dollar would provide quite a stimulus to the stock market in the short term, and the economy in the long term.
In short, I think it’s dangerous to be too dogmatic about which way the market could move in the event of more economic turmoil. My gut feel says the market won’t do well, but that doesn’t mean it will work out that way.
In an era of central bank dominance, you have to be flexible and expect the unexpected.
That’s why I like to keep an eye on the charts. The charts provide big clues as to what is really going on. Interpreted correctly, they can either confirm or refute your ‘gut feeling’.
Which is why I regularly consult Quant Trader Jason McIntosh. Jason has over 20 years of trading experience, and can read a chart better than any professional I know.
If you want to learn more about Jason’s chart reading skills, you can sign up to this four part video tutorial series that I recorded with him earlier this week. It’s packed full of great insights, with plenty of working examples.
If you want to take your trading or investing to another level, I strongly suggest you watch the series. Best of all, it’s free!
Until next week…
For Markets and Money, Australia