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The central bank ‘risks’

‘We should not make the mistake of believing that we have put an end to financial crises’ – Stanley Fischer

Federal Reserve
Source: Bloomberg

- The ‘stability’ in financial markets from central bank action is probably one of the biggest positives in the post-GFC era. The fallout effects for achieving ‘stability’ aside; central bank action has allowed wealth creation, a liquidity backstop to minimise risk and increase investment, boosted lending while also positively impacting business and personal confidence.

- The issue is, that it has bred complacency – something that is ringing alarm bells with me. The US is currently smack bang in the middle of Deutsche Bank’s ‘emotion index’ which measures index complacency. The ‘mildly’ positive trade overnight shows very clearly that the market is indeed just that – complacent about risk.

- The risk in the global markets are simmering under the surface – Grexit, increases to the Fed funds rate, China’s equity valuations (still a massive bright spot though as officials need equity appreciation), Japan’s QE program to ‘nowhere’ (what happens when they run out of bonds to buy?), ECB’s QE program (the periphery’s issue with disinflation, Germany’s concern around mass inflation) and Australia’s inability to pull up the slowdown in the economy from the collapse in mining while facing a housing market that is being described as a bubble.

- But don’t take my word for it – ‘one reason we should worry about future crises is that successful reforms can breed complacency about risks’ – Stanley Fischer once more.

- I am an optimistic person by nature, I believe by the end of 2015 we will be entering a new stage of the cycle and that there will be upsides in the economy, as rates in Australia finally catch up in business thinking and feed into earnings. Housing regulations will have slowed the frothy movements in the housing markets in Sydney and parts of Melbourne and equities are likely to see FY16 and FY17 guidance improving – driving the ASX higher and considering the underperformance year-to-date it may even outperform heading into Christmas.

- However; my interim view is, unfortunately, pessimistic. On current earnings and even with the pull back of the past two months, the ASX is still considered elevated compared to historical averages and the ASX small cap index is even more elevated.

- Industrial small caps are trading at a 40% premium to their historical 15 year average at 18.9 times. Companies between 151-200 on the ASX 200 are trading on a 24% premium to their historical 15 year average. The largest firms on the ASX 200 (ASX50) are at a 7% premium – considering how closely followed they are, that would be considered to be elevated.

- The risk to the ASX is that it’s a reactionary market not a leading market; and the fact the S&P is trading on a trailing PE of 18 times - its highest level since 2010 - and is staring down the barrel of an increase to the Fed funds rate in the next four month means the ASX is facing global headwinds coupled with local factors.

Ahead of the Australian open

RBA Tuesday - no cut today; all markets and economists agree on that – interbank market is pricing in a 3% chance of a cut today and all 28 economist say no change.

The variations come with what is to be said. The language in the statement will be everything – Most expect a recognition of last week’s bleak CAPEX and construction numbers, but not all.

Most also believe an easing bias will be reinstated into the statement – the AUD is telling you that is the market’s belief. However, economists are divided here; some say it won’t be reinstated and that a neutral stance will be adopted.

If there is no change to the final paragraph in today’s RBA statement; does that signal the end of the easing cycle? That rates are at terminal velocity? And the rates chamber is bare? Does that mean the RBA has no further scope to move monetary policy? No, it does not. However, it does show the RBA believes it can’t really do anything else to assist the Australian economy with rates alone – the likely reaction in the market today would be a pop in the AUD and a gyration in the ASX.

We are currently calling the ASX up four points to 5739. The futures market is just as flat as everyone from property investors to AUD traders to equities investors turn their attention to Martin Place and the 2:30pm AEST announcement.

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