The ‘Australian moment’ passes

Since the GFC the local economy has enjoyed what was dubbed by George Megalogenis the “Australian moment”. It was argued that three decades of reform had positioned Australia to weather global ructions better than anyone else. That we occupied a unique position regarding China and a falling US dollar that pushed up commodity prices and attracted investment even as our low public debt did the same. It was argued that this was a structural shift, with no end in reasonable sight. Today, it’s looking rather more cyclical than that. From UBS comes a note explaining why:

Given the recent pull-back in equities, we take stock of price movements across regions and sectors. The beginning of the move seems to have been triggered by concerns over Fed tightening and then extended as concerns rose over the spike in Chinese interbank rates. And then last week, not to feel left out, Europe joined the party with echoes of previous Euro Zone crisis fears as the Portuguese Government wobbled.

We continue to be of the view that rising bond yields, from these ultra-low are bullish, not bearish for Global Equities, if they are rising for the right reasons. The problem over May and June was that the rise in yields was too rapid. Our Global Flow watch report shows investors were heavy sellers into the Quarter end in June, with the biggest net selling for nearly a year. We suspect as the rate of the sell-off in bonds moderates, Global Equities will recover previous highs.

To get a notion of how radical has been the move in bonds, check out these charts from Credit Suisees via FTAlphaville. The largest monthly bond run in history:

But on a longer time frame either not so bad or more to come:

Regular readers will know that I think that the taper is too fast already, will slow growth, and that will slow this shift from bonds and safety to equity and growth. But I do not expect it to reverse. The Fed has cast the die, timing is the issue now. And that is hitting Australian assets hard. Starting with bonds, from David Uren yesterday:

The Australian economy has a “sell” sign hanging over it as US and Japanese investors redirect their portfolios to their home markets.

Although it tracks only a tiny slice of the foreign exchange market, the Chicago Futures Trading Commission’s report on trading on the International Monetary Market shows there are more speculative short positions on the Australian dollar now than at any time in the 21 years of the series.

Global bond funds, monitored by the data firm EPFR, show global investors have been heavy net sellers of Australian bonds for the past four months and of equities for the last month, with net sales in the last four weeks of $500 million in equities and $1.3 billion in bonds.

Analysis by UBS of the March quarter financial accounts shows foreign investors are deserting the market for Australian government bonds, which they had dominated for the past six years of rapid growth.

Over the last two quarters, foreign investors have taken just 30 per cent of the increase in government bonds, whereas they were buying 80 to 90 per cent of issues a year ago.

Analysts say overseas central banks are not selling their holdings of Australian government bonds but they have sharply slowed their purchases.

But the selling doesn’t stop there. Back to the UBS note:

Winners & losers: MSCI World is off 5% from the May highs, not a massive move, but digging beneath the surface there have been some major shifts. We look at a Global Heatmap of relative performance in USD since the trough in bond yields (May 2nd). The stand out performers in regions have been the US and Japan. The biggest underperformers have been Brazil (down a whopping 19% relative), Australia, India and China. At a sector level autos, general retail and diversified financials have been the winners, mining and bond proxies (property and utilities) have been the losers.

So, taking a matrix of the regions and sectors together, the best place to be has been areas such as US autos (+15% relative) and the worst, Brazilian miners (-26%) and Australian banks (-18%).

And here’s the chart. Check out the red on line six:

Or, in aggregate terms:

What of the future?

We stick with our bullish view on Global Equities with the US and the UK our favoured regions. The US still offers the best growth / valuation trade off. We upgraded the UK to Overweight two weeks ago (please see our Global Equity Strategy report “Upgrading the UK: the next US?” June 19). One of the key reasons was the improvement in the macro momentum as the UK continues to de-couple from Europe. Since then, the macro data releases have been very strong – the UK composite PMI is at a 6 year high and the housing market is clearly turning with mortgage approvals close to a 5 year high. The arrival of the new Governor of the BoE has been a further catalyst.

At a sector level we continue to favour a somewhat more cyclical bias with Overweights in Tech and Financials. Healthcare is the only defensive sector we overweight. We would continue to avoid the “expensive defensives” such as Consumer Staples, which we think will likely underperform as bond yields rise, earnings downgrades continue on the back of weaker EM FX and the global economy gradually heals, providing better opportunities elsewhere.

In short, anywhere but here. Don’t get me wrong. We had our moment all right. But that’s all it ever was – a moment – and believing otherwise threatened our own success. In the medium term, expect Australian bonds and equities to continue to under-perform and the Australian dollar to continue to fall, eventually restoring balance to our economy.