Wounded Bull or Emerging Bear Market?

Last week was a brutal one for the Australian share market, especially the last few days. On Wednesday, the ASX 200 finished down 43 points. It then rallied 55 points on Thursday, only to plunge 108 points to finish the week.

The start of the week doesn’t look much better, either. The S&P 500 fell by more than 1% on Friday, and our market is down nearly 50 points in early trade.

So is this just a steep correction before the resumption of the bull market or something more sinister? No one really knows…it’s a question I’ll keep returning to as the year moves towards and end, because it’s obviously a crucial one.

But sometimes looking at what makes it into the mainstream media can give you clues as to how things are unfolding. Today’s evidence comes from the afr.com and AMP…about as mainstream as you can get when it comes to financial information:

As the global sharemarket selloff intensifies, investment strategists and managers of multi-asset portfolios remain committed to equities and say they are more likely to see plunging share prices as a buying opportunity.

And fears of a “great rotation” out of high-yielding stocks in 2015 look overblown, with global monetary conditions likely to remain extremely accommodative despite a mooted hike in United States interest rates around mid-next year.

“We reduced our exposure to Australian shares in August, but we are going to use the recent weakness as a buying opportunity,” said AMP Capital’s head of dynamic asset allocation, Nader Naeimi.

The month of October “has a reputation” for market troughs, Mr Naeimi said. “The low is not to [sic] far from here and should set the springboard for a strong fourth-quarter rally.”

So the herd thinks this correction is a buying opportunity. That gives you some idea of the complacency that is still around. Which is understandable. Although the US Federal Reserve’s QE program is just about over, interest rates remain low and in such an environment, equities represent good relative value.

And in the world of funds management, it’s all about relative value. But the biggest risk for shares here is the performance of the global economy. If slowing growth starts to impact on company earnings, share prices will struggle to get back to previous highs anytime soon.

So while I can see market bouncing higher for a few weeks following this current sell-off, it may not be sustainable. Keep in mind too that the Australian stock market has suffered quite of bit of ‘technical’ damage over the past few weeks. As you can see in the chart below, the ASX 200 sliced through the 200-day moving average (blue line) in September…and kept falling.

That’s in contrast to all the corrections experienced since the strong rally got underway in late 2012. Each time the index previously hit the 200-day MA, buying support came in and stocks soon moved higher.

This time it’s different…

This time around though, it’s different. The bullish buying support just isn’t there. In fact, each attempted rally has been an invitation for more selling. That’s telling you that the psychology of the market has changed.

I would put that down to foreign speculative capital getting out of Aussie stocks, with local fund managers coming in and buying the pullbacks. But right now foreign sellers are overwhelming local buyers.

At some point the foreign selling will exhaust itself, and then you’ll see a decent rally. The important thing to look for then is how far the rally goes before it peters out.

Of course, much of that will depend on what’s happening over on Wall Street. If you look at a chart of the biggest equity market in the world — the S&P500 —it’s not quite panic stations just yet. Friday’s 1%-plus decline saw the index close right on its 200-day MA. So we’re still in a plain vanilla correction phase for US stocks.

The S&P500 — a standard correction…so far

But it’s the first time the S&P500 has been anywhere near this important long term average for nearly two years. The bulls will want to see a decent bounce from here…the bears will want to see the falls continue.

My best guess is that you’re going to see further falls before we get a strong rally that sucks a lot of investors back in. It simply ‘feels’ like something has changed over the past month or so. That is, the market is no longer as seduced by the Fed and other central banks as they once were.

A good example is the apparent nakedness of Emperor Mario Draghi, boss of the European Central Bank (ECB). Just a few months ago, markets rejoiced in the expectation that the ECB would pick up the money printing baton from the US Fed.

Now, that assumption looks decidedly shaky. Draghi may be a master orator but the structure of the ECB (meaning German resistance to US style debt monetisation) hamstrings his ability to take meaningful action. Ironically, this is helping Europe now as its currency falls against the US dollar.

But who says that debt monetisation (money printing) works anyway? You’ve seen unprecedented action from central banks all over the world, and where are we? Trapped in various asset bubbles, with weak underlying economies.

History will prove our current monetary managers to be utterly incompetent. After going through 30-plus years of debt accumulation, spending and consumption, can you believe central bankers’ sole aim is to lower interest rates to get us to spend more? Does anyone really think this is going to work beyond the next election cycle?

Of course not. But when career politicians (and their cronies) try to run an economy within the confines of election cycles, you’re going to get constant short-term ‘fixes’. These fixes will give the appearance of working momentarily, only to ‘disappoint’ and invite more half-arsed solutions.

Eventually (like now) this constant short-termism creates massive long term problems. How such a situation resolves itself is anyone’s guess. But the resolution is not normally pleasant.

A small example is the problem surrounding the Aussie government’s budget. Despite the strongest terms of trade boom in history, we’ve had a budget deficit for years. The government came up with a bunch of spending cuts in the last budget that were so unpopular they stand little chance of getting through, meaning the deficit problems remain.

Now their revenue forecasts look shaky because of falling coal and iron ore prices, which mean the budget deficit will get even worse in the years to come.

The sensible thing for the government to do here would be to get consensus for broad tax reform. That is, make the tax base broader and more equitable (fairer). This is crucial because we have an ageing society where spending increases are a given in the years to come. In other words, the government will expect a smaller working population to provide for a (relatively) larger population in retirement.

Without tax reform, we either go into more debt, or tax the productive part of the economy more. Both are poor options from a long term perspective, but political decisions aren’t about the long term, they’re about power and political survival. That’s why the government isn’t even talking about tax reform…it’s too hard politically.

Which suggests this rolling crisis, both here and around the world, will continue to roll on until it crashes into something. Whether that something is war, an increasingly authoritarian state, or the rise of a new political force is impossible to tell at this point.

But what is easy to see is that politicians and central bankers, instead of working to get you out of the hole they put you into, are simply digging it deeper.


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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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