Despite how convincing market experts appear on television or how cleverly they put pen to paper, the truth is that nobody knows for sure how the global economy will perform next year. For every positive sign or trend there is a worrying one, and despite the Dow Jones having some strong days recently the fact is the U.S. economy is still in bad shape.
In the world’s second biggest economy, Japan, a fragile economic recovery seems to be taking hold but the auto-makers still have excess capacity, deflation looms and exports volumes are still soft especially to the U.S. Many Japanese companies also believe it will be hard for commodities prices to creep back up in 2010 as they anticipate that demand from China will be lower. This appears to differ from the RBA’s view and raises doubts about a commodities lead recovery in Australia in 2010.
At present the Chinese economy seems to be ticking along nicely but let’s not forget this is due to a massive government economic stimulus package and that Chinese exports are way below levels seen before global financial crisis struck. Can China really keep achieving economic growth of around 8% over the next few years without demand for it’s exports picking up strongly? Maybe. maybe not..who really knows?
The general consensus view from the IMF, OECD and G-20 is that the global economy is now slowly healing. If we look at oil prices, the Baltic Dry Index (BDI) and various stock markets around the world it is pretty clear that these all bottomed out in late 2008 or early 2009. But just because oil prices for example have risen off their lows does not mean the world has entered a growth cycle so we need to be wary of reading too much into trends.
To illustrate the point I am trying to make let’s have a look at the Australian stock market and oil & gas prices.
ASX All Ordinaries vs AMEX Oil & Gas 4 year chart. (Nov 09)
Over the last 4 years the ASX All Ords (XAO) and the AMEX Oil & Gas Index have followed a pretty similar path. This is because in simple terms if the world economy is doing well then the demand for oil and gas will be up and this will drive prices for these commodities higher. If commodity prices are heading higher then our stocks market will generally get a boost since mining and financial stocks dominate both the All Ords and ASX 200 indices.
What the chart above shows is that from March 2009 both the All Ords and oil & gas prices have trended upwards but simply looking at the trend alone is misleading. What we need to factor in is that markets tend to fall too low when a major shock hits the financial system. In other words, gas and oil prices were driven to their lows not by fundamentals alone but by fear and once this fear subsides, they will creep back up somewhere near where the fundamentals suggest they should be.
So the trend upwards in oil & gas prices and the Australia stock market is at this stage simply a reversal of a correction that went to far. It might appear that the ASX All Ords is doing, well but if you stand back and look at the 4 year view all we are really seeing are stocks creeping back up to levels seen in late 2006. Yes the trend is positive, but I would not take it as a sign that we have returned to a growth cycle just yet.
What we can say with some certainty however is that the Australian stock market is unlikely to retest the March lows this year and may never get near those levels again until the next big financial crisis comes around. (yes there will be another one)
Despite a few down days over the last week or so, the ASX All Ordinaries has been on the up now for most of 2009 and seems determined to reach 5000 at some point as the chart below suggests.
ASX All Ordinaries Index 2 years chart. (Nov 09)
However as I have been saying for months now, the stock market will most probably hit 5000 (maybe even this year) but it will be tough going from that point upwards as there are still plenty of reasons to be cautious about the Australian economy.
Finally let me look at my old friend gold since I appear to be one of the few people around who is not a gold bull and bothers to look at gold prices in Australian dollar (AUD) terms. Yes gold might be a good way to get rid of some of your U.S. dollar reserves but for Australian investors let’s keep it simple and look at gold in AUD terms.
Gold price per ounce in Australian Dollars over 1 year. (Nov 09)
In one year gold in Australian dollar terms has risen by 6.57%, but remember you earn no income from holding physical gold or owning gold via an Exchange Trade Fund. (ETF) This means gold has underperformed Australian stocks over the same period and has even underperformed the Shareswatch Random Portfolio by a long margin.
But almost every day we see in Australian newspapers and on financial websites stories about how gold has hit a new high price which is true enough if you look at gold only in USD terms. But why on earth would any Australian investor simply look at gold in U.S. dollar terms during a period when the USD is losing value?
Remember for gold to continue heading up in USD then new buyers need to keep entering the gold market and the United States dollar has to keep sliding backwards. Many investors obviously see this situation continuing but I don’t, and believe when the music stops playing a lot of people won’t be able to find a chair.