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Australia 200 on the cliff edge

From afar, the outlook for Australian shares is declining. This is of particular importance as the Australia 200 Index is sitting on a key support level and looking increasingly fragile. Should the international view of investing in Australia remain negative the impact could be disproportionate.

When a broker doesn’t know why a stock is falling the glib response is “more sellers than buyers”. While it’s intended as an exercise in the bleeding obvious it speaks to the key determinant of stock prices – the balance between supply and demand. It is the marginal buyer or seller that drives share prices higher and lower. Pressure from international selling is potentially a game changer.

There are a number of factors keeping international investors away from Australia. Some realistic, others less so.  An example of the latter is a general scepticism about the Australia’s unbroken 26 years without recession. This is the longest run of any modern, emerged economy. However a simplistic belief that a market has gone too far or too long rarely leads to profitable investing.

The strength of the housing market also raises eyebrows overseas. The repeated 10-15% yearly gains in major cities causes concern, especially in light of long standing calls of impending residential doom. Many more agile international investors have already tried short selling Australian banks to gain exposure to the long touted housing market collapse. This trade is now known as “the widow maker” in hedge fund circles.

However there are better reasons for global investors to shun Australian shares. Recent shifts in the regulatory environment are a negative. The impost of a levy on bank liabilities apropos of nothing other than a budget deficit and bank unpopularity rang alarm bells. The heavily regulated energy industry and the shifting of goalposts by state governments also deters foreign investment. This is not a major issue for international investors at the moment because Australia is still seen as a good business environment overall.

More worrying is the recent down draft in commodity prices. Industrial metals, precious metals and agricultural markets are down significantly on July prices. While analysts don’t change their long run commodity forecasts for short term moves, investors often do. The existing down trend is enough to ring alarm bells particularly given Australia’s longstanding status as a capital importer.

The biggest issue affecting international perceptions is beyond Australia’s control. Recent data in the US shows continuing improvement in the US economy. The US Federal Reserve is explicit about intentions to withdraw stimulus funds and lift interest rates. These measures are supportive of a higher US dollar. A broad reform of taxation in the US which is mooted to include a one off amnesty for repatriation of offshore profits adds to the strength. Naturally a higher US dollar means a lower Australian dollar.

Add in downward pressure from falling commodity prices and the local currency outlook is sobering. From a global viewpoint a 5% return in a share market is of no interest if the currency is likely to drop 10% over the same period. Overseas sellers could punch the market through the bottom of the recent range. Any tumble below 5,650 could spark technical selling and a rout may eventuate if momentum builds.

It’s important investors pay attention to current market action. Selling outright or protecting portfolios with investment tools like put options and CFDs could prove prescient in the absence of global support. It’s often said that share markets go up via the stairs and down via the elevator, highlighting the sharp nature of sell offs. At the moment overseas players could be reaching for the down button.

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