Stock markets around the world have had a very volatile run over the last few weeks with everything from debt levels in Europe to housing statistics in the U.S. giving scaring investors. But during times of market volatility it is important to try and spot the longer term market trends and not get carried away by sensational headlines or daily market swings.
Back on May 24th I suggested that the Australian stock market has fallen too far and that the market correction was overdone. I also wrote that I expected the ASX All Ordinaries to rally back up towards 5000, so before I go on let’s check to see how things have turned out so far.
ASX All Ordinaries (XJO) 3 Month Candlestick Chart
Well despite many market commentators saying that the Australian stock market would fall below 4000 and the doom crowd as usual talking about a new market low, stocks have actually rallied since I made my call as I suggested they would.
Am I a market genius? Of course not, I simply realized that there was so much bad news swirling around that the stock market was likely to fall too far. After some time when investors had digested all the information they would shrug off some of the bad news and start to gradually buy stocks again. That is what has basically happened.
However the Australian stock market is not enjoying a solid rally and as I have mentioned before the market is telling me that the economy is not doing as well as the Government, Treasury and Reserve Bank are suggesting it is.
If we look at the next chart we can see how the All Ords is stuck below 5000 and as I said last year, I expected the market to trade between 4800 – 5200 for quite some time. In actual fact the trading range has been more like 4600 – 5000 but I still feel it should be trading in a range a little higher than it is now.
ASX All Ordinaries (XJO) 3 Year Candlestick Chart
What we can see from this chart is how volatile the market was during the fall to the March 2009 low and then how that volatility has gradually decreased. It is tempting to think that the market is swinging madly during a correction phase and certainly stocks are bouncing around quite a bit, but if we look back over the last 3 years things have actually calmed down considerably.
The chart above also shows how hard it is for the ASX All Ordinaries to break through 5000. Again last year I talked about this at a time when most market commentators were talking about the commodities boom and how the Australian economy was the envy of the world.
The fact is that most Australian companies are not enjoying boom times and the economy has been artificially propped up by Government spending and by households taking on more debt to fuel the housing market. Much of the developed world is suffering a debt induced hangover and yet in Australia the debt party continues. Our hangover will come along sooner or later, and when it does it could be particularly nasty.
But maybe I am wrong, sure the Australia stock market is down but so are other markets and the U.S stock market is in terrible shape right? Well actually not, and over the last 3 years the ASX All Ordinaries (XAO) has underperformed the Dow Jones Industrial Average. (DJIA)
ASX All Ordinaries versus Dow Jones Industrial Average 3 Years Chart
Despite unemployment in the United States being around 10% and the crash of the housing market, the Dow Jones has still managed to outperform the All Ords over the last 3 years. Of course the U.S Government has borrowed and spent billions to support their economy but so has our Government so we can discount this as the only reason why the Dow Jones is holding up pretty well.
The one year chart of the All Ords versus the Dow Jones is also interesting to look at.
ASX All Ordinaries versus Dow Jones Industrial Average 1Year Chart
What we can see from this chart is that when commodities prices or commodities related stocks are falling in Australia as they did in April/May then our market under-performs the Dow Jones.
If you believe Australia is going to enjoy a mining boom that will last for decades and shower riches across the land then you would probably think our stock market will outperform the U.S. market in the years ahead.
However if you feel that perhaps the Australian commodities boom has been over-hyped then you may reckon that the Dow Jones will do better than the All Ords over the next decade and personally this is what I expect to happen.
So why do I remain cautious about the outlook for commodities when it seems everyone else is talking about a boom? Don’t I read the business news from Australia? Aren’t I aware how well the resources sector is doing? (Apparently it is doing so well that the Government wants to tax it even more!)
A major reason for my cautious outlook can be explained by the Baltic Dry Index and as regular readers of this blog will know, I keep a close eye on the BDI!
Baltic Dry Index 1 Year Chart (Bloomberg)
I watch the BDI because it is good indicator regarding how shipborne trade is going. If large amounts of goods are being shipped around the world then the BDI tends to rise but as these volumes fall (or are predicted to fall) then the BDI will tend to trend lower.
Clearly the BDI is not rising strongly at the moment and in fact has fallen from over 4000 to around 2600 in a matter of weeks. This does not suggest to me that shipping companies are being flooded with requests to ship everything from iron ore to wheat around the planet so this leads me to be cautious about the outlook for resources.
Maybe the demand for resources has already peaked due to the economic stimulus measures introduced around the world and is now starting to fall?
It is too early to know for sure if the latest drop in the BDI is just a short term correction or if it is indicating that we might see some slowdown in global trade. All I would say is we should be wary of a post World Expo economic slowdown in China and not get carried away by the talk of a decades long commodities boom in Australia.