The financial worriers are back.
Down goes the Australian stock market – by 0.5%.
And down goes the Australian dollar – by more than a cent against the US dollar since the start of the week.
What’s caused it? A drop in business spending.
The market thinks that’s bad news. But it’s not, it’s good news. Just not in the ‘bad news is good news’ kind of way.
Here, let us explain…
First off, here’s how the Sydney Morning Herald reported the latest news:
‘The Reserve Bank is facing a new headache as a big drop in company spending adds to the evidence that the rest of the Australian economy is struggling to take up the slack from the slowdown in mining.
‘The Australian Bureau of Statistics reported business spending expectations for the three months to December fell by a greater than expected 5.2 per cent.‘
Analysts had expected businesses to forecast spending of $139 billion, while the actual number was $124.9 billion.
You know what that means don’t you? That’s right, interest rates if they move at all, are only going in one direction, down. Yet the market hasn’t figured that out yet.
Currency traders get it, stock traders don’t
In recent weeks the market has fallen for the spin from the Reserve Bank of Australia (RBA). That’s the idea that the interest rate cutting cycle is over.
That’s why the Aussie dollar stopped falling and bounced back two weeks ago. But with the latest business forecast for lower spending, the Aussie dollar is on the way down again.
Why? Because currency traders must reckon interest rates will stay low and perhaps go lower.
That should be good news for stocks. But surprisingly, the Australian stock market fell too.
It’s funny. Because it seems as though stock investors have forgotten all about the impact of low interest rates on stocks. They’ve forgotten that when interest rates are low, it forces investors to look for alternative investments.
The natural beneficiary of this are stocks…in particular dividend-paying stocks.
That’s why it doesn’t make any sense that stock prices would fall. We can only think that most investors have forgotten about the impact that low interest rates have on stocks.
Clearly most investors have short memories.
Now, we’re not saying that dividend stocks will put in the same type of gains that you saw from late 2012 through to 2013. Our bet remains that growth stocks are the best place to put your money in 2014.
But it does suggest that with the Aussie dollar on a downward move again, currency traders have worked out what stock investors have missed.
Recession yes; falling stocks? Maybe not
Of course, as we mentioned earlier this week, the level of the currency doesn’t really matter when it comes to Aussie stock prices.
Looking back over the past 10 years the correlation between the Aussie dollar and Aussie stocks has been minimal at best.
What’s more important is the direction of interest rates. And despite all the recent talk of the end of the interest rate cutting cycle, we’re still sticking to our call that the RBA will cut rates to below 2% before the year is out.
If that happens, it should help boost stock prices over the coming year, pushing them towards our near-range target of 7,000 points. After that, even bigger gains are on the cards.
If that’s not good news we’re not sure what is. But at least the market hasn’t fallen into the ‘bad news is good news’ trap. The market reacted exactly how you’d expect it to react. That tells us the market still isn’t looking far enough into the future, which means it’s still a great opportunity to buy into stocks.
So when the RBA starts making noises about cutting rates or actually goes ahead and cuts them (perhaps as early as next Tuesday), you can expect stocks to put in a good run as growth investors consider the positive impact of lower interest rates, and income investors begin to scout out the best dividend stocks on the market.
Our old buddy Dan Denning says 2014 is the year that the Aussie economy goes into its first recession in 22 years. We won’t argue with that. The one thing we will say is that Aussie stock prices may have already built in that possibility.
China still dominates
So rather than a recession creating bad news for stocks, it could have the opposite effect as investors begin to look past the expected bad news and look ahead to a recovery, especially as China’s economy keeps growing.
In short, when reading the headlines, it’s hard to look past them. But if you take a moment to think things through, you can start to look past the report’s surface, and instead focus more on the consequences of the news.
The consequences of a poor near-term outlook are likely to mean interest rates stay lower than most people think, and that should mean good news for stocks.
Cheers,
Kris+
PS: You can quiz me on my bullish stock market views in person at the upcoming World War D conference in Melbourne at the end of next month. I’ll be on the stage with global finance gurus Dr Marc Faber, Jim Rickards, and Satyajit Das. You can find out more here about what I consider to be the best money and finance conference in Australia this year. Click here for the revealing trailer…
