Traders are regularly dismissive of economic analysis. Terms like “dismal science” and “driving while looking in the rear view mirror” feature when some traders discuss economic forecasts. Despite a lack of faith in the market predictive ability of classical economics, most traders still pay attention. They must - mainly because other people do.
Markets move with the majority. When buyers outgun sellers, prices go up. When sellers overwhelm buyers, prices go down. The factors that make buyers and sellers change their minds are therefore critical in determining market direction. Many institutional and individual investors pay attention to economic data, rightly or wrongly.
However, like company earnings, it’s not the outright level of the numbers that counts, but where they drop relative to forecasts. Earlier this month investors saw the ABS release Gross Domestic Product data. Yearly growth slowed to the lowest level in ten years. This decline was widely anticipated, resulting in a muted market reaction.
The GDP level had little impact, but the components of the national accounts contain clues for investors. Two days before the headline release inventories data showed a decline of 0.9%, significantly below estimates of a 0.3% gain. Some analysts hit the panic button, revising estimates of a 0.5% quarterly lift in GDP into negative territory.
One day before the GDP release the exports component once again surprised. This time the lift of 0.6% beat forecasts of a 0.3% rise. The big drawdown on inventories was largely absorbed by a surge in exports. A likely driver is the lower Australian dollar, and the surprises tell us that most analysts underestimated this effect.
The Australian dollar has weakened from a peak above 80 US cents in early 2018. Over the second quarter of 2019 the slide continued, and the Aussie approached ten-year lows near 68 cents. The slide occurred across multiple currencies, including the Japanese yen and the Euro. No doubt there was cheering from the Reserve Bank headquarters in Martin Place, and the Treasury building in Canberra.
The popular view of the currency as a national scorecard is a misconception. Any change in the level of the Aussie produces winners and losers. However on balance a lower Australian dollar is good news for the economy. Australian goods and services are more competitive in the global marketplace, and local demand for international purchasing at least partially turns back to local producers.
In short, the lower currency stimulates the Australian economy by importing demand.
The effect of the lower Australian dollar has important investment implications. Many investors are puzzled by recent gains for the Australian share market. Trade disputes, unrest in Hong Kong, the uncertainty of Brexit and data showing softer growth in major economies are all causes for investor concern. The seemingly relentless negatives are hard to reconcile with a stronger share market.
The long and gentle slide in the currency usually falls under the media radar. It is the unseen balancing item to so many of the negatives that hog the headlines. The implications for investors go further. The weakened dollar makes Australian shares cheaper for international investors.
Additionally, a number of stocks and sectors may look attractive to international peers. If the Aussie remains at lower levels one possible consequence is an increase in overseas companies taking over local companies. This week’s bid for dairy food group Bellamy’s may be one of many while the Australian dollar remains lower.
Effects of a drop in the dollar can also show up on company bottom lines. Where company costs are locally denominated and earnings are international, profits increase above and beyond increased demand.
The companies in this position are reasonably well exposed, and include CSL, Cochlear, James Hardie and Newcrest, among many others. Investors still need to do their own research and decide for themselves whether currency benefits are already reflected in a share price. Nonetheless the recent experience suggests the benefits of the fall in the Australian dollar are underestimated, at least at the macro-economic level.