“Everything has a price. I’d buy anything at a [certain] price if it’s not going to zero”
-Hedgeye Managing Director of Financials, Josh Steiner; 1/5/11
Conclusion: Australia’s economic fundamentals are deteriorating and we expect near-term weakness in their equity market and currency as a result. We do, however, like both Australian equities and its currency over the intermediate-to-long term and will be looking to buy them on a pullback.
Position: Cautious on Australian equities and the Aussie dollar over the near-to-intermediate term; bullish on the intermediate-to-long term.
On December 2, we published a note tilted: “Moderation Down Under”, whereby we outlined several factors that are explicitly bearish for the Australian economy (email us if you need a copy). I’ll save you the time by omitting the details, but, briefly, they are as follows:
- Chinese growth is slowing and the full extent to which China could tighten and slow its growth is being disrespected by global equity markets;
- Rising interest rates are weighting on Australian consumer confidence and boosting the savings rate; and
- Weakness in Australia’s Manufacturing sector continues unabated, contracting for the fourth consecutive month in December to 46.3. Australia’s Service sector also exhibited signs of recent weakness:
In addition to these bearish factors, layer on “biblical” and “unprecedented” flooding (as termed by State Premier Anna Bligh) in the Australian state of Queensland spanning an area the size of both Germany and France combined. The region accounts for roughly 20% of the nation’s A$1.28 trillion ($1.29 trillion) economy and is the location of 73% of the nation’s coal production – Australia’s largest export commodity.
Given this confluence of factors which could lead to slowing growth domestically, why be long Australia?
The answer comes down simply to price. We are bullish long term on Australia because of its commodity production as rising demand from developing nations that may perpetuate global supply shortages. In addition, burgeoning sovereign debt issues in the E.U. and the U.S. will likely serve to keep a floor under commodity prices over the long term TAIL.
In addition to its positive exposure to commodity inflation, we want to be long countries where sobriety reigns supreme in its fiscal and monetary policy (i.e. Australia, Germany and Canada). RBA Governor Glenn Steven’s wasn’t afraid to raise Australian interest rates several times last year to ward off inflationary pressures and Prime Minister Julia Gillard is currently weighing spending cuts to make good on her election promise to balance Australia’s budget in three year’s time. The current flooding in Queensland won’t help, but it will likely help us find a better entry price on the long side when it’s all said and done. Moreover, at 22% of GDP, Australia’s public debt load compares rather favorably with countries we isolate as the worst from a fundamental perspective for a variety of reasons (Spain, U.S. and Italy).
In other news, today's global macro run finally produced some bearish sentiment (albeit moderately bearish) surrounding The Great Down Under. Regarding the Aussie dollar, Thio Chin Loo, currency strategist at BNP Paribas said today:
"The markets are playing it with a very cautious attitude and if China continues to step on the brake to slow growth, then the bets will still be on the downside for the Aussie dollar at the start of the year. So I wouldn't dismiss if the weather situation does not improve or the Chinese policy makers would decide to enact further tightening measures, then the Aussie could clearly break parity."
We expect more bearish sentiment to creep into the market and weigh on the Aussie dollar and Australian equities – at which point we’ll be looking for an entry on the long side of either. To Josh’s point above, every investment has a price and duration. Irrespective of the fundamentals, getting both of these correct is the key to making money on either the long or short side.
From a quantitative perspective, Australia’s All Ordinaries Index is broken from an immediate-term TRADE perspective and bullish from an intermediate-term TREND perspective.