The Australian All Ordinaries Index historically follows the USS&P500 Index on an approximate 60% daily probability basis. Recently the S&P500 along with other US indices have been trading lower primarily in response to higher US interest rates. The US Federal Reserve is undergoing a process to try and normalise US interest rates; as rates are lifted, Government bond yields lift and this makes stock markets relatively less attractive.
The grey stripes in the Effective Federal Funds Rate chart below are recessionary periods in the US economy, it can be seen generally that as interest rates are increased this commonly leads into a recession. Meaning that the Federal Reserve has a history of acting too aggressively when lifting rates, and this is obviously a concern for the stock market.
Effective Federal Funds Rate
In addition to the US stock market pull back, the local stock market is concerned about a weaker Australian housing market, which is also a negative influence on the price of Australian Banks, and a weaker growth performance from the Chinese economy. This is showing up as slightly weaker global growth and there is the possibility that current US and Chinese trade negotiation tensions could further slow global economic growth.
It is important for investors to remember that credit driven stock and property markets have a natural end as debt levels eventually reach a natural limit, while there may yet be some more downside to come in the stock market, we do not expect the Federal Reserve to drive rates up so aggressively as to cause a US recession, at least for several years.
We expect further price declines in Australian housing and for this to maintain pressure on Australian banks.
Importantly for the Australian market will be the performance of the Chinese economy and level of Commodity demand.
At this stage we maintain a conservative and defensive view on the stock market, though would increase this defensive positioning if the Chinese economy and commodity market started to slow more aggressively or financial pressures lifted in the EU, in countries like Italy.
We currently expect the US and Australian stock markets to range trade going forward, as the US Federal Reserve acts to balance rate lifts with US economic growth.
Australian All Ordinaries chart