Eye on the market, 20 August 2019

We’ve seen plenty of market action in the last couple of weeks.

The local market on July 25 hit a record high after the previous all-time high set back in November 2007, on the eve of the GFC.

The closing market high happened on July 30 – the All Ordinaries Index closed at 6928.33. Heaven forbid that this record will stand for another 12 years – we have a lot of pain ahead if that’s the case.

As luck would have it, just as we hit the high, all hell broke loose. The recent rally which took out the old high has been all about interest rates. The RBA, in its wisdom, cut official cash rates in June and July. Overnight cash now stands at 1 per cent and rates right across the yield curve – from 90 days banks bills to 10 years bonds are under 1 per cent! When I was checking rates I had to do a double take – when I saw 0.65% next to the 90-day bank bill I wasn’t sure if I was looking at the rate or the price!

In the history of humankind, and indeed in the history of the universe, Australian rates have never been below 1 per cent. Our kids will be able to tell their grandkids they lived in an age of historically low rates!

The low rates fuelled the share market rally. A few years ago, you could get 5 per cent on a term deposit. Rates are now well under 2 per cent. So, where do you put your money to get some yield? In higher risk investments like shares, which still boast attractive dividends.

 

Australian All Ordinaries Index over the 12 months to August.

Dow Jones Index over the 12 months to August.

If we have ultra-low rates, why has the share market fallen 5 per cent in the last week?

Firstly, the reason the market fell at the end of last year was partly because the US Federal Reserve had a tightening bias. The reason the market rose this year was because it backed away from raising rates and gave signs it may lower rates. That happened last week. However, the chairman of the Fed, Jerome Powell, quashed the idea that it would be the start of a rate cutting cycle, instead referring to it as an adjustment.

His words upset the market, i.e. investors. Thereafter, the leader of the western world, escalated trade tensions between the US and China by announcing he would raise tariffs by 10 per cent on $300 billion of Chinese goods. Hasn’t he read the history of the world? China then devalued its currency, presumably to offset the tariff so that Chinese exports would be cheaper. Thus, we had a very sharp sell-off which will probably continue between now and the end of the year.

Shares that have been hardest hit are tech stocks – the WAAAX’s got smashed this week; and resource stocks – BHP and Rio are down the best part of 10 per cent as a result of falling iron ore prices.

Iron ore prices, as we know, went through the roof after another dam disaster in Brazil which took about 40 million tonnes out of the market. The price hit about $120 / tonne. Inevitably it has to fall, and so will Rio, BHP and Fortescue. The price is down to $105 but as supply is still curtailed it may not fall much further in the short term.

The tech sector has run hot this year – not just the Australian tech upstart companies collectively known as the ‘WAAAX’ (Wisetech, Afterpay, Altium, Appen and Xero), but also some that are below the radar, e.g.) Nearmap, Nanosonics and Rhipe. The band stopped playing this week and there was some blood on the street. The sector needs a good shake out – it has been far too hot. We are in earnings season and all of these companies report this month. Should any one of them disappoint there may be a pretty savage sell off in the sector. To maintain their lofty valuations, they need good results.

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