Australian Market Weekly Wrap

Greece is getting its money it seems but any chance of a relief rally that was sustainable in markets was undermined by a combination of weak data, strange comments from the world’s two most powerful central bankers and a focus not on Spain but the even bigger fish of Italy.

For my money I really think the key here is that there is a rolling crisis that the dithering European Politicians are making worse but that the creeping realisation amongst market players that the global economy has turned down is really what is undermining any ability to hold onto gains. My view is that we are in for a continuation of this for a little while yet.

Indeed we saw weakness in the Chinese Flash PMI during the weak which, I don’t think saw too much airplay, but got our pulses racing. Coming on top of this was the German ZEW survey of business confidence which is at its lowest level since early 2009 and then we also saw European economic data such as manufacturing and services indices off.

And then we had Fed Chairman Bernanke after the FOMC meeting this week admit that he and his colleagues at the Fed don’t know why the economy is slack at the moment which renders both his claim that this is transitory and his expectation that H2 will see stronger growth as USELESS.

It also means that the market can only go with the data as a guide and the guidance is weak weak weak.

Not to be left out ECB president Trichet decided that he didn’t want all the focus on problems in the US and weighed in with this amazing comment that the European banking system is in real strife. Bloomberg reported his comments as,

European Central Bank President Jean-Claude Trichet said risk signals for financial stability in the euro area are flashing “red” as the debt crisis threatens to infect banks.

“On a personal basis I would say ‘yes, it is red’,” Trichet said late yesterday in Frankfurt after a meeting of the European Systemic Risk Board, referring to the group’s planned “dashboard” to monitor risks. “The message of the board is that” the link between debt problems and banks “is the most serious threat to financial stability in the European Union.”

Trichet, who chairs the ESRB, made the remarks as European leaders meet in Brussels to discuss how to stave off a Greek default, while preparing a second bailout.

We know why he said this, he’s trying to keep the pressure on Politicians to fund Greece. But all this does is highlight to the market that if Greece is big enough to drag down the banking system then what about the rest of the region. And so we had Moodys following up last week’s news about the italian Sovereign rating with an announcement that it was  considering downgrading Italian Bank credit worthiness. This is partly what took markets down last night.

So at the end of the week any thoughts of a post Greek confidence vote bounce had been washed out and markets closed the week looking, no other way to say it, weak.

Commodities

Commodities seem to me to be leading the way on the realisation about growth which is why i think its more than just Greece and Europe. these are important in their own right but in a global economy that is weakening they are just an additive feature not the cause.

This chart above is the CRB index and you can see that it is now in a clear downtrend having broken the QE2 uptrend in early May and is also right on important technical support. My fundamental view based on growth and a resurgent USD (well at least its picking itself up off the mat) is that this index and commodities generally will continue to slide.

Equities

Equally strong a downtrend is the Dow jones Industrial Average which is sitting just above important support but also in a post QE downtrend. 11,776 is important support in the sense that it is both the 200 day moving average and the 31.8% rettracement of the QE2 rally.

I’d expect the data to put pressure on this market and thus the technical levels mentioned above need to be watched closely.

Likewise for the Australian equity market the pressure is on. 4473 is still the big level it needs to hold above and so far it has. remember that the correlation with the Dow and S&P has been rising across the course of 2011 so we will continue to take our lead from there but it also looks like Australian data is weakening still so domestic induced pressure is on the rise

We still favour options cover (or a move to cash) while this plays out.

FX – Australian Dollar

On the FX market the AUD is under pressure again but has held in magnificently SO FAR. I’ve posted my weekly Australian Dollar Wrap over at MacroBusiness but the high level summary is that it looks like it is going to retest, probably break the 1.0440/50 support and head toward the 1.0350 and then 1.0200 levels. We’ll see how it looks after that.

Elsewhere in currencies the USD is looking much better and is biased to higher levels as you can see in the chart below.

You may wonder why this is the case when I have just been talking about a weak US economy. The answer is that the USD is both the global bellwether still but also a funding currency so when risk goes off a little funding currencies rise. Also the Euro is suffering under its own weight which is also supporting the USD.

Interest Rates

In Australia we now know that the RBA has come around to our way of thinking insofar as they recognise that even though they have a medium term view that the mining boom is an economically transformative event the reality that the rest of the economy is under pressure is a clear and present danger.

Here is the piece we wrote earlier in the week after the release of the june minutes but we’d also like to reiterate one point we made in that piece,

THIS IS A SERIES OF SIGNIFICANT ADMISSIONS ON THE WEAKNESS IN THE NON-MINING SECTOR AND I THINK AND ACKNOWLEDGEMENT THAT THE RBA DOESN’T UNDERSTAND WHY HOUSEHOLDS ARE SO CAUTIOUS

Equally the conclusion to Phil Lowes speech yesterday seems to reinforce the point the rest of the economy is struggling,

It is not easy to navigate our way through this difficult environment. The new realities of the global economy have improved Australia’s medium-term prospects. At the same time though, they are causing considerable structural change in the economy which is leading to difficulties in a number of areas.

So add this realisation on a market that is short (expecting rates to go up) and all the problems offshore and rallying interest rates and we have rates in Australia that are probably too low for the RBA’s tightening bias. 

But that doesn’t mean they can’t go lower.

3 year swaps closed this morning just under 5% and 4.75/80 seems to me to both be a magnetic zone an a good place to do some hedging – no rush though.  

10 Year Govies are also biased toward 4.75 and if they get through there it would have to be on the back of more global weakness as the Australian generic 10 year has been trading in a broad but very strong range for some time. However a move below 4.75 probably implies something is up and they could head toward 4.50%. Down there or below would however feel too low though given the Australian fundamentals but given it would be driven from offshore we’ll have to see when/if it gets there.

All in all markets are at really important levels and junctures. The market and economic outlook is deteriorating, yet we havent had a pessimistic crescendo, so it’s probably not over yet.

Circumspection remains our mantra.

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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