Macro issues have been, and will continue to be, a major headwind for the Australian market. Along with these and domestic factors, we take a look at the future of the ASX 200.
Macro issues
China's economy and the PMIs
The government recently re-iterated its stance to push the Australian economy back into surplus by 2013, and as a result our reliance on China's growth is stronger than ever. It seems the main worry about China's economy has shifted from inflation and overheating to its growth slowing excessively in the next few months. French bank Societe Generale recently said the People's Bank of China may raise interest rates twice again this year, and increase lenders' reserve-ratio requirements three more times, in a further bid to cool the economy. The PMIs (Purchasing Management Index) in response to previous tightening measures dropped to just above 50, and if we start seeing future readings below 50 (below this figure shows contraction in manufacturing), the market and the AUD could really struggle.
Looming Sovereign Debt
Sovereign debt issues have been lingering in the background for some time but seem to be getting more credence again, causing panic in many asset classes. Looking at the fixed income and credit default swap (CDS) markets, they are clearly telling us that a restructure is on the cards somewhere down the line. If Greece is allowed to restructure, will Ireland, Portugal and Italy want the same treatment? And what will be the potential losses to the global banking system, traders ask? Markets are hoping for further financial aid in the short term to Greece, which, if provided, could cause a relief rally in risk assets. However, it is quite clear that traders don't see this as a long-term solution because it does not address the issue that they can't raise taxes and cut spending fast enough to grow their economy. A restructure further down the line will have to happen in some form, and as a result, the sovereign debt issues in southern Europe will continue to be a headwind for the foreseeable future.
Domestic factors
The ASX 200's underperformance
One of the notable nuances of the Australian market this year has been its relative underperformance against other major equity markets. It has been the subject of much discussion, but can be broadly attributed to policy uncertainties stemming from a compromised minority government, the uncharted strength of the AUD wreaking havoc on Australia's industrial sector, and ongoing concerns about Australia's susceptibility to a Chinese (slowdown given our nation's heavy dependence on mineral exports).
Political uncertainties
While Australia is no doubt at the mercy of a Chinese slowdown, the uncertainties created by our own government's proposed MRRT and carbon tax have heightened industry confusion about our nation's future 'operating environment'. In doing so this has greatly tarnished our sovereign risk profile. Anecdotal evidence suggests that offshore investors are rethinking their capital allocations to Australia, with other Asian jurisdictions, home to more stable governments and certain tax regimes, a more attractive bet. This situation is certainly one of the more valid explanations for the underperformance of the Australian market and is one that is likely to persist until the negative perceptions of our country's current political landscape are corrected.
A technical focus on the market
A look back
From the bear market lows in March 2009, the ASX 200 staged an impressive rally of 60% into the October 2009 high around 4900. Since then however, the market has basically traded in a large sideways pattern between 4200 and 5000. More recently, from around September 2010, this pattern has tightened with support moving up to around the 4550 – 4580 zone. While the market has basically been range bound, there have been plenty of short- to medium-term trends for traders to take advantage of.
The market now
Fast forward to today, and the market has once again pulled back to test the 4550 – 4580 range. We have a strong confluence of support here, meaning there are a number of technical levels all converging, which gives it more significance and importance. Both the long-term and medium-term uptrends are combining, whilst there's also strong horizontal support from previous lows through the 4550 – 4580 zone. The 50% Fibonacci retracement level of 4576 from the May 2010 low (4175) to April high (4976) is also adding further support.
The market ahead
Last week saw a significant amount of buying come into the market around these long-term support levels. The strong rejection of the week's lows was testament to this. Whilst the market is facing numerous headwinds (both domestic and global), we would expect to see these long-term support levels hold. Our gut feeling is that we will continue to trade in the lower half of the 4550 – 5000 range for the next few months, as markets work their way through the concerns currently on hand as the seasonally weak May – July period runs its course. From there, market consensus turns decidedly more bullish, with many participants forecasting a strong end to the year, much like we saw in 2010. A push towards and through 5000 could certainly be on the cards barring any unexpected developments.
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Updated: 01/06/11
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