Warnings renewed of troubles ahead

A bear market indicator has hit ts highest level since the late 1960s and early 1970s. Pic: AP

The Australian nation at the end of last month received its first clear warning from the share market that there were dangerous times ahead.

You will remember that in documenting the share price falls I passed on the warning via the comment titled Market turmoil gives us a warning. Now this week we have received a second warning but, like the first warning, the covering of excess short positions can trigger a major turnaround at any time that obscures the deeper warnings. We saw that on Wall Street last night, but the market still closed markedly lower.

This second warning is different from the first and also more dangerous for Australia. The second warning duplicated the overseas signals but locally we are now starting to see the vicious downward cycle stemming from the unprecedented credit squeeze being imposed on the nation by APRA, the royal commission and the other regulators.

There are now grave fears that they may not understand the impact of their actions at a time when the US and global markets are falling.

This week Goldman Sachs’ bear market indicator hit 73 per cent—-its highest level since the late 1960s and early 1970s. This tool predicts not only zero market returns on Wall Street in the year ahead but is a confirmation of the dangers of further market falls.

This indicator brings into play all the major economic signals (manufacturing data, unemployment etc) and compares this data to share price earnings ratios. The Goldman warning sign is being confirmed by lower Apple orders which have spooked the market this week and the slump in the oil price, which reflects sluggish global demand at a time when the US is increasing oil production.

That higher US oil production is a big US stimulator, while Apple sales are akin to an economic barometer.

To this we add the US political turmoil. Part of the problem is that US shares are priced on the basis that nothing will go wrong with the US growth story. Once Wall Street starts to have doubts it can infect the economy.

On Wall Street overnight, an afternoon wall of selling hit the market and investors rushed to switch from shares to bonds which jumped in price as yields fell.

Then in the final hour there was a share buying rush and bond prices eased.

The Federal Reserve is planning to raise interest rates next month - a move that looks a lot more dangerous than it did before the first market warning last month.

Back in Australia yesterday I contrasted the bullish statements of the Reserve Bank with the slowdown warnings from the market and conveyed by Westpac chief economist Bill Evans. Bill and I have been around a long time and can often see dangers in the real world that theoretical economists can miss.

The share markets’ danger signals are telling the Reserve Bank economists to leave their Martin Place bunker and go out into the real world. Go and talk to bank branch people (not CEOs) and learn how APRA rules are cutting bank lending by at least 20 over cent but usually by one third.

And as the lower lending drives dwelling prices lower, the amount of lending falls again which lowers the house prices and the circle goes around again.

Go out and talk to the vast numbers of ordinary Australians under mortgage stress who are suffering from the higher energy prices created in part by Victorian and NSW government bans or curbs on gas production.

Talk to ordinary people who cannot shift dwellings because they can’t negotiate a loan equal to their present borrowing to fund a replacement dwelling, or to investors who are under the pump because interest-only loans have stopped.

Come and listen to the Victorian politicians in the election campaign promising to spend vast amounts on stamp duty revenue that will not be there because dwelling sales are slowing. Hear the fears of the 1.4 million battlers who will be hit by the ALP’s proposed retirement and pensioner’s tax and an equally large number who will be affected by the proposed negative gearing rules.

At this stage employment is strong and with labour shortages wages are rising. But the stock market is warning us that as the credit squeeze lowers house prices, the political turmoil is going to hit the real economy.

Sometimes markets are wrong and that also applies to veteran economists and journalists.

On the global stage it is Apple and the oil price that are the tangible confirmation of market fears.

In Australia if the market is right the cracks will appear in the interim reporting season.

But a small crack did appear this week. One of Australia’s largest retirement home builders and marketers, Aveco, was expecting to sell 1500 homes in 2018-19 but has reduced the target to 1150 because the fall in house prices means people are not selling their homes and buying into retirement villages. Aveco has also experienced unfavourable media publicity.

I hope this second danger warning proves to be a fizzer. For that to happen China and the US have to reach agreement and the European problems must be overcome.

And here in Australia the royal commission needs back off (unlikely) and APRA needs to ease the credit squeeze (even more unlikely).