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Australian stocks indicate the economy is still struggling.

October 14th, 2009 · Greg Atkinson · 4 Comments

The Reserve Bank is clearly now back in the mood to fight inflation and the recent decision to rise interest rates confirms that they believe the Australian economy will fare well in 2010. But if their economic outlook is correct, then why haven’t stocks rallied further?

Some months ago I suggested that the path back to the 4800 – 5000 level for the Australian stock market would be relatively easy but that it would then be difficult for the market to rally much past that point. This is because I believed stocks simply fell too far after the collapse of Lehman Brothers and that eventually investors would realise that the world had not stopped turning.

As can been seen from the chart below of the All Ords Index the overall stock market has continued to rally strongly over the last few months. Clearly the trend has been upwards and although there have been some periods where investors have taken profits, generally buyers have been keen to enter the market.

ASX All Ordinaries Index 3 month chart

asx-all-ordinaries-3-month-chart-oct-09

But the rally on the stock market has probably been more to do with investors moving back into stocks on the belief that the worst of the global financial crisis is over, rather than simply a vote of confidence in the Australian economy. In other words the market is being driven higher because a devastating global recession seems to be avoided and not because of any particularity fantastic domestic economic news.

Remember the All Ords/ASX 200 are still well below the highs of 2007 and although there has been a sustained rally much of this has to do with stocks simply recovering from being over-sold. Many companies are still struggling to deal with the fallout from the credit crunch and next year is likely to be a year of recovery, not rampant growth.

If we look at the stock prices of BHP & CBA over the last few months we can see clearly how relief has pushed the overall market upwards.

All Ordinaries, BHP & CBA 3 month chart

all-ords-cba-bhp-3-month-chart-oct-09

The chart above highlights how Commonwealth Bank (CBA) has out performed the wider ASX All Ords by a significant margin over the last 3 months and despite all the hype about trade with China, shares in BHP Billiton (BHP) have underperformed the wider market although they have still risen by over 10% since the end of July.

What this charts suggests to me is that although the rally in stocks has been broad it is really a rally of two parts. Part one is a strong rebound in financial stocks as investors become convinced that the global financial system has been saved from a meltdown and part two is related more to the overall global economy.

For me part two is more interesting as the Australian stock market will only push significantly higher now if global trade starts growing again. My view is that the relief rally is almost over and for the All Ords/ASX 200 to move significantly past 5000 then we need data that indicates that global economic growth is gaining momentum.

I am not suggesting that stocks will stop rising over the longer term, however I do believe that the prediction by some stock market watchers that shares will rally up near the highs of 2007 this year or early next year will not happen. In fact I doubt we will see the All Ords/ASX 200 anywhere near 6500 even in 2010.

Over the next few months how Australian stocks will perform will largely depend more on companies like BHP rather than CBA. If mining exports pick up and Australian exporters see increased profits then the market will push higher, however if global growth remains weak then I expect it is going to be hard for the market to push much higher over the last quarter of 2009.


4 responses so far ↓

  • 1 Mike Harmon // Oct 14, 2009 at 10:15 am

    I found your blog on google and read a few of your other posts. I just added you to my Google News Reader. Keep up the good work. Look forward to reading more from you in the future.

  • 2 Anon // Oct 14, 2009 at 12:33 pm

    Well summed up. I dont see how the BHPs etc are going to lead us higher from the data I am seeing.
    I wouldn’t be suprised if the materials sector underperforms the rest of the market for the next 12-18 mths.

    “If mining exports pick up and Australian exporters see increased profits then the market will push higher, however if global growth remains weak then I expect it is going to be hard for the market to push much higher over the last quarter of 2009.”

    Well said – I agree.
    The tech sector will likely outperform over the interim aswell… Intel just blew away bottom and top line forecasts !

    Hey just a side issue – above not advice, only for debating – pls see a financial advisor for decision making and advice.

  • 3 Dan // Oct 14, 2009 at 10:26 pm

    I agree the ASX 200 will find itself running out of momentum next year, even with continued improvement in the underlying economy. It will likely punch through 5000, provided that global economic and political stability doesn’t change suddenly.

    I’ve read a lot of negative assessments though for the US, with the Federal Reserve likely forced to raise interest rates (central banks have lost faith in the USD and are buying Euro and Yen) to prevent an ongoing flight of capital away from there. Might this have knock on effects for Australia, with China having to keep waiting for its biggest customer to start buying again?

  • 4 Greg Atkinson // Oct 15, 2009 at 7:33 am

    Anon – I reckon you are probably right about the tech sector, sadly we don’t really have one in Australia though.

    Dan – I also read a lot of reports from the U.S. that don’t make me feel particularly optimistic about the prospects for significant growth there for a while. Yes the U.S. economy might not be contracting as fast as before, but people are still losing their jobs and it is going to be extremely hard for the economy to pick up enough to re-employ those people. (not to mention create new jobs for people entering the job market for the first time)

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