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The ASX All Ordinaries, Dow Jones and the Baltic Dry Index.

June 23rd, 2010 · Greg Atkinson · 14 Comments

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

asx-all-ords-3-months-chart-jun-10

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

all-ords-3-year-candlestick-chart-jun-10

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

all-ords-vs-dow-jones-3-year-chart-jun-10

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

all-ords-vs-dow-jones-1-year-chart-jun-10

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)

baltic-dry-index-1-year-chart-june-10

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.


14 responses so far ↓

  • 1 Niko // Jun 24, 2010 at 10:04 am

    I think your right about government stimulus running out of steam, it’ll be interesting to see how the lower Euro effects China.

  • 2 Greg Atkinson // Jun 24, 2010 at 3:16 pm

    Niko something just doesn’t add up. I keep reading bullish outlooks for China but three of their main markets Europe, the U.S and Japan aren’t exactly surging ahead.

    Also the factory strikes in China are going to make companies think of locating production elsewhere. So after the World Expo we might see a post-Olympics style slow down in China?

  • 3 Anon // Jun 24, 2010 at 9:42 pm

    “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.”

    Yep 75% of my portfolio is in the United States…and my OZ portfolio has alot of stocks that benefit from a higher USD. Most of my commodities exposure is related to oil…altho commodities is only about 10% of the portfolio…my big bets are in Walmart, Citigroup, Pfizer and Sanofi (70% of portfolio).

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 4 Ned S // Jun 24, 2010 at 11:17 pm

    Just commented on another article of Greg’s that it will be interesting to see if Obama can hold the G20 together re further stimulus.

    I think when one is considering how markets might perform comparatively over the next decade, stuff like the following could have an impact:

    http://en.wikipedia.org/wiki/Triffin_dilemma

    http://en.wikipedia.org/wiki/Bancor

    Although I’ve got to admit that I’m definitely not bright enough to figure out what any such impact might be!!!

  • 5 Greg Atkinson // Jun 25, 2010 at 12:54 pm

    Ned I can see the merit in moving away from the U.S dollar as a reserve currency. The ‘bancor’ makes sense to me..I even like the name 🙂 How much would a beer be in bancors I wonder?

  • 6 Ned S // Jun 25, 2010 at 1:27 pm

    A basket of commodities as the basis of an international reserve currency that is not specifically tied to the economic doings and health and interests of any particular nation seems to make a lot of sense to me too Greg. It’s just possible the IMF SDRs could get a guernsey on the way there perhaps? Do you want your pay in Bancors or Beer? Tough decision eh! 🙂

  • 7 Ned S // Jun 25, 2010 at 2:48 pm

    I wonder if there is any correlation between market corrections and upcoming G20 meetings?

  • 8 Anon // Jun 25, 2010 at 5:50 pm

    i’m not a fan of using the BDI even though alot of people seem to like it.

    Found this interesting:

    “But essentially one problem with using the BDI for economic forecasting is that the BDI could feasibly go up in an environment where commodities demand was shrinking, if the supply of ships was shrinking even faster. These would be negative economic factors. This is because the BDI’s value is not solely driven from the demand side. To me, it makes far more sense to just look at nominal demand for commodities rather than the BDI since the BDI has the complicating factor of vessel supply growth one needs to consider. The other thing is that the BDI is a measure of spot rates for dry bulk commodities consumers who, generally, are in the near term forced to pay whatever it takes to get their raw materials shipped (A steel plant needs to keep operating despite some higher ore transportation cost). On the flipside, vessel owners are in a similar boat (no pun intended), and in the near term are generally forced to take whatever rate they can get to fill their ships. (A ship sitting around is just a cost, ie. fixed costs are high, thus using a ship at a loss is usually better than not using it at all)

    Because of these inelastic characteristics of supply and demand, and since the BDI is a measure of spot rates, the BDI is thus absurdly volatile. I can explain why via the following simplified example, which I used to use frequently at Citi.

    Imagine you have 10 loads of iron ore and 9 ships, and that every load of iron ore must be sent no matter what while every ship must be filled no matter what. Imagine the bidding war between those 10 iron ore consumers fighting over just 9 ships. Shipping cost would skyrocket since they all need to ship regardless of cost. Now imagine if a week later two more ships enter the market. Now imagine the bidding process. Suddenly the tables have completely changed. You have 11 ships, that all need to be filled no matter what, and only 10 loads of ore. Shipping rates would plunge, despite a period of just a week passing by. This is, in a simplified nutshell why the BDI is so volatile.

    Now, add to this the fact that predicting ship supply and commodities demand has a pretty high margin of error, at the same time remembering how sensitive the BDI is to small mismatches due to the inelastic nature of its underlying supply and demand, and you quickly realize that predicting the BDI is a fool’s game and also that it is not a reliable forward indicator given that it is a spot rate index in a market where both sides are basically forced to close a deal due to high fixed costs. The BDI is measure of supply/demand mismatch at the moment, and can change drastically on a dime. Its little else beyond this. It hit its peak not when the global economy was in its healthiest state, but in early 2008 when things were already starting to come apart, but Chinese commodities demand growth still had some steam and just kept outstripping stagnant vessel supply growth. For a moment. And then it all collapsed. And BDI correlators got annihilated in popular stocks such as DryShips (DRYS). Thus, let’s hope that we put to rest any talk of the BDI as a reliable leading indicator, even if in six months someone datamines some new, latest correlation.”

    http://www.businessinsider.com/the-cost-of-global-shipping-is-a-lousy-economic-indicator-2009-5#ixzz0rqvEwxtx

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 9 Anon // Jun 25, 2010 at 6:06 pm

    “I wonder if there is any correlation between market corrections and upcoming G20 meetings?”

    Not sure? But if you’re suggesting we are going to have another major correction here I think that could be a possibility but unlikely? But I have portfolio insurance in place in case I am wrong of course, and to limit the drawdowns.
    Looks like end of financial year tax loss selling, and seasonally this seems common for end of June.
    Perhaps sideways for awhile and then grind higher over the next 6 months.

    I do think that this is the last year for awhile for decent returns…so we better take advantage of it before the bear market takes hold again.

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 10 Greg Atkinson // Jun 25, 2010 at 8:28 pm

    Anon there are a lot of problems with all economic indicators I would say, but if you know their limitations they can still be useful.

    When looking at the BDI I suggest people also look at world shipping statistics such as scrapping rates, new orders and the number of vessels laid up.

    The picture does not look good to me. Capacity is being taken out of the system via scrapping and laying vessels up and yet the BDI is still falling.

    Of course a lot of new ships are hitting the water as a result of orders placed years ago but even so it looks like capacity is still falling as is demand.

  • 11 Anon // Jun 25, 2010 at 10:22 pm

    Thought this was an interesting read:

    What’s the point of macro?

    http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2010/06/21/what-s-the-point-of-macro.aspx

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 12 Ned S // Jun 25, 2010 at 11:09 pm

    Thanks Anon – Particularly noted this bit of the article: “There is absolutely nothing wrong with “trading these markets” if that’s what you love doing and it’s what you’re good at. But the evidence clearly shows that the vast majority of us aren’t. Worse, the vast majority of those who think they are good at it aren’t either, and they will be competing against traders who are.”

  • 13 Anon // Jun 25, 2010 at 11:45 pm

    Yep thats a good point Ned. Alot of traders underperform the market, even though they think they are really good. I think theres a time to trade, theres a time to invest and theres a time to do nothing and sit on the sidelines. Grouping yourself into a catergory may work for some people but perhaps its better to change as the markets do; instead of just using stern principles and rules througout?

    Also, I think its important not to get overconfident and always make sure you allow for mistakes.
    Mistakes are a constant and admitting them quickly is really important.
    ATM my hit rate is unusually high but I fully expect it to drop as time goes on. Hence why i’m focusing on more outliers than just trying to make sure I am right 80% of the time (which is unsustainable).
    Outliers are the keys to the castle 😉

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

  • 14 Anon // Jul 1, 2010 at 10:41 pm

    When it rains it pours — more bad news!

    Jobless Claims in U.S. Increased Last Week to 472,000

    http://www.bloomberg.com/news/2010-07-01/jobless-claims-in-u-s-unexpectedly-increased-13-000-last-week-to-472-000.html

    Lets see if the markets start rising on bad news…thats usually a bullish signal !

    Please remember this is just for discussion. This isn’t advice. Always seek a qualified financial advisor who knows your circumstances when making decisions.

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