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2011 has been a volatile time for the ASX 200. Domestic equities have been plagued by the same issues that have dominated the international investment climate for the past year. The combination of European debt-levels reaching boiling point, a flailing US economy and the Australian dollar continually breaking new ground are making it very difficult to ensure stock selection and portfolio outperformance. Australian markets will always fall victim to the turmoil inflicted on international markets to some extent, regardless of the strength of our local economy.
With interest rates at 4.75%, a robust resources sector and unemployment around half that of most developed countries, there is no doubt Australia has one of the best-placed economies in the developed world. So why do we continue to pay the price for the underperformance of US and European nations? It appears we may have priced ourselves (or rather been priced) out of our own market.
Looking at the ASX 200, technicals have been pointing toward major resistance around 5,000 for quite some time. On several occasions it appeared the market may attempt to break this resistance, but a new move higher was always going to prove difficult. Technical resistance levels were well publicised and it appears a large portion of the market sat on the ‘sell-trigger’ as the index crossed its 200-day moving average. But at what point do investors begin to see value? In the short-term, markets appear range-bound and a pull-back toward 4,200 remains a likely scenario.
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It’s not all doom and gloom from here.
It is easy to lose sight of the long-term direction of the market and of Australia as an active investment arena. Our markets remain in an upward trend but at the time of writing, just about every market commentator is pointing towards a move to the exit and a return to more dire circumstances. While it seems likely there may be a near-term downside, the bigger picture points toward a range-bound market with ample opportunities to profit in between.
The rise of the Australian Dollar
In many cases, one would think that a strong economy would have net positive impacts on domestic equities. With a strong economic base, Australia has seen a solid inflow of foreign funds into Australian dollars. Our dollar has seen its own technical patterns emerge, briefly setting $1.10 as the highest rung on the ladder. With the AUD now well and truly set into this range, domestic equities face their strongest headwinds as Australian products are priced out of the global market. Nearly every major Australian company is affected by export trade and major trading partners can no longer afford to do business with Australia.
And why would they? With cost pressures affecting the balance-sheets of businesses world-wide, companies simply cannot swallow a 30% rise in the cost of Australian goods and services, as they have experienced over the past year. The AUD’s strength puts the majority of export-producing companies in a very difficult position - a rising Australian dollar means that not only will share prices suffer, but jobs will also come under the hammer as potentially many jobs are outsourced to a more affordable, offshore labour force.
The Australian export industry remains a difficult investment environment, affecting just about every listed company to some extent. Finding those with the least exposure to a fluctuating dollar remains core to outperformance. With the exception of the materials space, export industries will continue to struggle to make exceptional profits with the Australian dollar at current levels. From tourism, airlines and education through to consumables – lower offshore earnings result in huge reductions to profits.
Take Qantas for example: airlines rely heavily on international business. Whether filling flights to Australia or fulfilling demand in offshore operations, a higher Australian dollar has played a major part (alongside rising commodities prices) in what has been a slow start to 2011. A strong Australian dollar will continue to weigh on local business and it pays to look closely at Elliott Wave and other technical indicators to confirm pockets of value in today’s difficult investment climate.
Australian Resources take charge
Much of Australia’s outperformance can be attributed to a robust and flourishing resources sector. Commodities prices have again sky-rocketed and exports continue to flourish. With a number of popular commodities priced in US dollars, raw materials look comparatively attractive. Add to this the continuing demand out of Asia and the developing world and large-cap miners are well-positioned to keep writing profits. While the dollar may impact earnings, a combination of increased demand and wet weather affecting supplies of coal and iron ore should see many Australian miners continue to maintain guidance for quite some time. But it’s not all rosy. There is no doubt that in the current environment the Australian mining sector will be influenced by headwinds in global equities. The key to achieving superior investment returns is through strict trade-management principles and the use of thorough, short-term analysis to time your entry. Stops must be tight and entry and exit criteria relative to key levels of support and resistance within this current trading range.
There are a number of materials-based stocks setting up for an excellent break to the upside. Accurate sector analysis is key. Note that while it may not be a smooth sail to the finish line, volatility creates trading opportunities and the overall trend continues to point north. Sift through the doom and gloom, wait patiently for technical confirmation of trades before entry and trade only those sectors which are more likely to perform according to current global headwinds.
Stay ahead of the game,
Lachlan McPherson
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