Little relief in sight for Australian investors

There are some dark forces at work in the Australian equity market at present and investors aren’t likely to see any relief today either, at least not on the open.

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We saw the ASX 200 close lower for five consecutive days in the first week of the year, but given our opening call of 5484 (at the time of writing at 08:30 AEST) it is hard to believe we will see a positive close; in fact, I would put around a 25% probability of this occurring. Strange things often do happen on a Friday however, especially given Chinese equities excellent pedigree on Friday, while many will also be eyeing US payrolls and a much anticipated OPEC meeting.

Compare the performance of the MSCI developed market to the ASX 200 and you can see the huge underperformance of the Aussie market of late. Since May the MSCI world has outperformed the ASX 200 by around 450 basis points. Another way of looking at this is by the ASX 200/S&P 500 ratio. Converted into AUD, and therefore taking currency moves out of the equation, the ratio is now at 2.01x, having fallen from 2.25x at the start of the year and 4.2x at its peak in 2007. This ratio is now at the lowest levels since 2003 and tells a story of huge over-performance relative to US markets, although the ratio against Japan and China would be even more pronounced.

There really has been nowhere to hide this week with all ASX sub-sectors down by more than 3% and the broader market looking for its worst weekly close since 18 May 2012, where it closed 5.6% lower. Financials have naturally put in the bulk of the points and the sub-index looks horrible on the daily chart. Westpac has already fallen by more than 20% in this drawdown and the other three big institutions are fairly close behind.

Take CBA for example; the consensus price to earnings ratio is 14.5x, which is certainly a more healthy level than where we were a few weeks ago but still 9% above the seven year average. The Australian 10-year treasury is also 60 basis points (or 0.6%) higher as well (in the last few weeks), which needs to be taken into consideration, relatively speaking.

It just doesn’t feel like the move lower in the banks is even mature. Many investors would have bought throughout April and many would have faced margin calls this week, although I am only speculating here. Many will be faced with the prospect of closing positions and given the strong drops seen since April most would feel that the bulk of the selling is behind us and that a bounce is due. This is exactly the same mindset as what happened during the GFC and although I am not comparing the macro backdrop to the GFC, the investing/trading psychology of holding onto losing trades is still in play.

In times like these hedging and capital preservation are paramount, while the downtrend on the charts would suggest shorting is even the way to go if one is keen to be aggressive with the market. With this in mind it will be interesting to see the short-selling data from the ASX next week to see if there is a marked pick-up in short interest. Remember banks don’t have structural issues though, so they will get to a natural point where the market sees strong absolute value and this will scare the life out of the short-sellers, but I am sceptical that time is now.

I think the daily chart of the SPI futures (June contract) tells the clearest picture and it looks like lower levels will be seen. Naturally if futures traders continue to short SPI futures the ASX will come along for the ride.

Other issues that I feel will be in traders’ minds today:

  • Iron ore has put on another 2.3% and looks rather bullish on the daily chart. BHP’s ADR is indicating a flat open however.
  • Greece looks set to bundle its IMF redemptions into one payment and will miss tonight’s €300 million payment. This shouldn’t surprise anyone given this has widely been talked about for the last couple of weeks, but price action in bunds and euro suggests it has.
  • The IMF has suggested the Federal Reserve hold off in moving the fund rate until 2016. With core inflation at 1.2% there is a strong argument here. Still, the Fed won’t take the IMF’s views into consideration.
  • US payrolls (released at 22:30 AEST) should be above 200,000 given the usual lead in data, but won’t move the dial too much unless we see a headline print below 140,000 or above 250,000. Hourly earnings are expected to be unchanged at 2.2%, but above 2.4% should put a bid back into the USD in a big way.
  • New York Fed president Bill Dudley speaks around three hours after the payrolls report, so he will provide us with a sense check on the jobs report. This speech is just as important as the payrolls in my opinion.
  • All eyes on Chinese markets. The moves we saw yesterday could be described as nuts, with the CSI 300 falling 6% from its earlier high and closing flat on the day. The high growth, high P/E ChiNext index had an 8% intra-day swing. A market for the bravest of souls.

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