Saturday, November 26, 2011

Building Approvals Foreshadow Recession

Australian building approvals foreshadow recession within about 6 months unless there are significant changes to policy settings in the next 3 months.

Note that the fall from the peak of monthly approvals figures in August 09 to September 2011 is almost 40%

The fall in the 12 month moving average from the peak in June 2010 to September 2011 is almost 15%, but most of this fall had taken place by January 2011. But allow for inflation of 3% pa and the fall in real value of 12 month average of approvals is probably 18% over the 15 months of the fall.

That must translate into lower construction and building supplies employment. Then there is the flow through into discretionary spending, retail employment, mortgage stress not fixable by interest rate cuts - all these lead towards recession and the lead time now might be as little as 3 months, given the timing of the majority of the fall in the average being already 9 months old.

Also note that 7 of the last 12 months were below the current average and 3 of the above average results included in calculating the average wash off over the next 3 months, suggesting the average will likely move lower over the next 3 months, meaning the inflation adjusted average fall at end December 2011 will likely be in the order of a 22% fall from the peak.

With a poor international outlook due mainly to Europe, tight credit parameters, high interest rates still (one cut isn't that much of a difference), and low confidence (ameliorated slightly by the change in easing stance), a greater than usual proportion of these approvals may not have translated into starts within the normal time frames and conditions are such that they may continue to be delayed further.

It is hard to see how these reduced approvals won't translate into a recession when unemployment increases among construction workers with consequent flow through the building supplies, retail discretionary spending, retail employment and possibly house prices through some increased rate of stressed sales.

The market still seems to be focussed on a resources construction boom, but:
1. isn't a proportion of that in the ABS approval data already
2. isn't some more than 12 months from approval, and
3. doesn't some of it require skills and relocations that may not be available in the domestic market?

Thursday, November 24, 2011

2011 Recovery (?) To Date (Day 44).

The 2011 bear market has so far bottomed at -22% on 26 September 2011.

While it feels like we have just had a failed bear market rally, it may be that we are still in a recovery from the 2011 bear market after 44 days.

Here is a chart of the first 100 days of recoveries from bottoms after falls of more than 20% since 1984, treating the bottom day as 0 and registering all recoveries in terms of percentage gains.

The chart shows that while we are at a point which is the lowest recovery at Day 44 we remain above the zero line and one recovery has been lower until Day 38 and another dipped lower for Days 58 to 63. in summary, we could still be in a recovery from the 2011 bottom, even though on fundamentals I am expecting otherwise.

While I am expecting to get triggered to sell within a few days if there are further falls, today's bounce has so far stopped me selling. I am very bearish, expect to sell based on timing strategies based mainly on moving averages and a modified "Turtle Trading" strategy and foresee a 1987/1991 market and economy double dip situation, we can't overlook the possibility that the recovery from the September 2011 bottom will continue and we should be buying the almost despair about Europe and mixed feelings about the US and China.

Tuesday, November 22, 2011

Bear Rally? From Recovery to Bear.

From earlier posts you have seen my graphics showing:
1. recoveries from prior bear market bottoms (
2. characteristics of market cycles ( and
3. market bottoms in particular (

The 1987 to 1991 Bottoms Bear's Eye View Chart

Today I am looking at how a market moves from one major bottom to another, irrespective of the length of time it takes and the shocks that take place on the way.  I have looked at each recovery individually using Mark Lundeen's "Bear's Eye View" where each new high is a zero score and each new level less than the last high is expressed as a percentage below that last high. As an example here is the BEV shart from 1987 to 1991. I chose this because my gut tells me that it could be very relevant in terms of the final bottom and it was the recovery from the last 50% fall before the 2007/8/9 fall of over 50%. It ends at the market bottom in January 1991after a fall of 30% from the last high achieved during that recovery. During the recovery from 1987 through to the bottom in 1991 the market never regained the high of 1987. We have already experienced this situation in 2009 to 2011 recovery as the market had a 20% fall from April to September 2011 without ever having reached the highs of 2007.

A couple of things you can see from the chart below:
1. There was a fall of about 12% very early in the recovery but the market reached new highs very quickly.
2. There was a period of about 8 months during which the market was down up to 14%, but again it reached new highs
3. The longer the Moving Average the less volatile and the more it follows the general trend of the market, but the more the market has moved by the time it changes direction.
4. During the major bear market leading to the bottom, there was a substantial bear market rally where using even a 90 day SMA as a timing indicator would have led to being whipsawn once, while a 10/30 cross of SMAs would have led to 4 round trip trades before the bottom, but the net result may have been better than trading the turning points of the 90 days SMA, depending on the buy/sell spread and transaction costs including stamp duties.

 The 30% fall took 16 months and brought the market back to 47% below its last all time high, almost to the level of 50% below its all time high. The level of the All Ords in January 1991 was within a few percent of the index in November 1987. Given the problems in Europe which could result in multiple sovereign defaults unless the ECB "prints" and supports sovereign bond issues, a repeat of 1987/91 for Australia is not out of the question. (Everything is linked directly or indirectly to Europe through trade, commodity prices or debt or affected by interest rates seeking yield and/or capital gain on long term bonds, it's just a question of how much the flow-on can be ameliorated by government and central bank interventions. My view is that it is far less likely to be offset by fiscal stimulus this time in many countries, and where it occurs is will have less dramatic impact than previously. It may ameliorate and slow the pace of recession but not prevent it.)

The Percentile Chart of the All Ords from Bottom to Bottom

I have also used a percentile chart based on each of these individual BEV From Bottom charts since 1987 to see what proportion of the time we have seen falls to particular levels like -20% and -50%. These percentiles are based on the market from the first new high after an absolute bottom of more than 20% (which is a zero on the BEV chart) to the next major bottom involving a fall of 20% or more (which in the recovery from the 1987 crash was a fall of 30% which some might consider as a reasonable proxy for the final outcome of the current bear market).

From the chart below we can see:
1. 50% of the observations have the market within 3.2% of the newest high since the recovery commenced.
2. The market is down 10% from the most recent high since the recovery commenced less than 20% of the time.
3. Four of the 7 market bottoms of more than 20% were between 20 and 22%, so diving in after a fall of 19% would have provided very good outcomes in those cases.
4. There are very few observations when the market is more than 25% below its most recent high even as it approaches a new bottom of more than 20%. The market has been more than 25% less than its most recent high during a recovery less than 3% of the time,

The big thing from this chart is that given we haven't had a rise of 20% since the September bottom, we might be in a bear market down 17.1% having just had a bear market rally and now falling away again, or the September bottom might be the final bottom and we are just down 5.3% from the latest new high in this recovery.  As there is no way to tell, you might decide to follow the price action based on eg the 10/30 SMA cross and sell.or go back to 50/50. My gut feel in the circumstances is that given US is at least stagnant and maybe entering recession and given the problems in Europe there is a real chance for a much larger fall, so following the price action at the risk of being whipsawn is my preferred course of action.

We see that only 5% of all observations are less than 20% of the most recent high. This is what leads to an investment approach of buying the market or certain sectors or stocks the moment the market is below say 19% or when it has a dramatically oversold position compare to some moving average or a dramatically negative 2 month or other short term performance. While the market may get much worse, historically you are highly likely to be in profit within 12 months unless the fall is eventually more than 40%. This problem has been avoided since 1984 if after a fall of 20% you wait for a medium length simple moving average of say between 50 and 90 days to turn up before buying or a cross of moving averages such as 10 crossing above 30. This is illustrated by looking at the BEV chart of the market from 1984 to now with a 90 day simple moving average.

One major qualification. The percentile would be quite different for Japan from 1990 or even '92 with far more common observations of falls greater than 10, 20, 30 40 and even 50%. The major risk is that most of the globe is in a balance sheet recession and that deficit hawks and bond vigilantes are driving austerity which leads to recession. It is this risk which drives me to be aware of reducing losses and not adopting the buy and hold strategy which has generally been so successful in Australia after a major fall in the markets.

Combining Percentiles, Bear's Eye View and Moving Averages

From observation (not backtesting which is beyond my time/computing resources/capacity) selling when the price falls more than 7.5% from its most recent high and then buying on an upturn of the say 90 day SMA would seem to insulate you from most loss during major bear markets but at the expense of occasionally having to sell and buy back with an opportunity loss (or even a real and realised loss) which would reduce your overall long term return.

But of course you could halve your volatility and maximum (hopefullly temporary,, other than if we are in a Japanese scenario) loss of value in your portfolio by having half in an index fund and half in bonds or being in a "balanced" fund, either of these at an average cost of only a few percent per annum in performance over the long term, and without having to constantly monitor your portfolio. The time that this wouldn't achieve a broadly similar result is in a situation like Japan 1990 to 2011.

You could also then switch to 100% equities after the 90 day SMA turned up after a fall of more than 20%, (which we know from our percentiles is only 5% of the observations from bottom to bottom) then switch back to balanced after the market went up say 15% and remain in balanced mode until the next fall of more than 20% and upturn in the 90 day SMA. This would reduce the losses incurred  from being whipsawn,   moderate the effect on you of "black swan" or "long tail" events (events which are a big deal but very rare and generally unforeseen.) and let you participate more in recoveries from major market bottoms.

Where are we now? The Dashboard is rolling over! Whipsawn by a Bear Rally?

Since my last Dashboard update the 10SMA has turned down (I average two lots of 3 days to reduce volatility), but the 10 day SMA is still above the 30 day SMA. I am also using a variation of the famous Turtle Trading System on a trial basis and my sell point on it is 4186. This system uses a series of trailing stops and leading buys that move with the market so that if the market falls more than a multiple of average daily volatility you sell and if it goes up more than a similar amount you buy. It is probably better suited to trading commodity futures, but can still result in significant cumulative realised losses.

I will sell if the All Ords closes below 4186 today and is below that level the following day at 2.30pm, or if the 10 SMA crosses below the 30 SMA whilever the 10SMA is trending down. My gut screams sell and I will have had a loss of a couple of percent from my August/Spetember purchases.

Could there be a Weekend Default/Withdrawal from the Euro?

I am thinking of selling on Friday no matter what as a surprise default and withdrawal from the Euro currency by Italy is probably in Italy's best interests now. If they leave it much longer the capital drain will have been very high. Would you have a deposit in an Italian bank now, given the sovereign is also in doubt? Not when I can deposit it in EURin a German bank in Germany instead or in Swiss Franks (CHF) in a Swiss Bank in Switzerland. Why would you take the default/devaluation/regulatory/tax risk?  I am likely being over-reactive in this, but the possibility is real. The worst result for Italy is two years of capital flight and recession inducing  austerity followed by a default and withdrawal anyway. Any default by one of the PIIGS or bank failure is likely to be on a weekend, so weekends are potentially dangerous times.

The TED/Libor Spreads and those compared to Germany of Spain and Italy are all elevated. The credit markets are likely becoming less liquid and some notable bond investors have reduced exposure to European sovereigns. When the banks are avoiding lending to one another it get's very dangerous. These TED and LIBOR spreads are nowhere near the highs of the Global Financial Crisis, but they are trending upwards very consistently.

Thursday, November 10, 2011

External Indebtedness - Australia in Bad Company

Australia has one of the worst Net International Investment Positions in the developed world at -61% of GDP in 2009 according to the Bank of Japan. (1)

Could we face action by "bond vigilantes" in the same way as Italy? 

Our position (2) is worse than:

Country Year % of GDP
 United Kingdom 2009 -13.1
 United States 2009 -17
 South Korea 2009 -17.8
 Sweden 2010 -22.2
 Italy 2010 -24.3
 Slovenia 2010 -35.1
 Mexico 2010 -36.5
 Brazil 2009 -37.5
 Kazakhstan 2009 -38.1
 Turkey 2009 -44.9

However we are in a better position than:

 Poland 2010 -63
 Slovakia 2010 -66.4  
 Estonia 2010 -71.8
 Greece 2009 -83.1
 New Zealand 2009 -90.1
 Spain 2009 -93.6
 Ireland 2009 -97.8
 Portugal 2009 -108.5

Is a position better than Poland and Slovakia but not as good as Kazakhstan and Turkey sustainable?

Is a position of 4 times as much net international investment as a percentage of GDP as the US and UK sustainable? And for how long? And can we allow our current position to deteriorate further? 

 In a world of "bond vigilantes" perhaps we need to examine our vulnerability. We have seen a number of myths exploded over the last few years:
1. House prices don't fall
2. Banks don't get bailed out,
3. Bank debt to foreigners doesn't matter of itself.
3. Western developed countries are immune to sovereign debt concerns.

While we have the benefit of being an issuer of our own currency (and can print and "quantitatively ease") to our heart's content, that doesn't help where our debt is denominated in foreign currencies, or we want to borrow more money from foreigners (remember the "Belgian dentist?).

We also have the benefit of low sovereign debt, but our states, while generally well rated, have large pension obligations under old defined benefits schemes many of which are indexed for inflation. The states can't issue currency and therefore need to fund these pensions over time as our demographics (dependency ratio) deteriorate.

The Federal Government has already had to guarantee some of our major banks borrowings from overseas which are needed because of the historically poor savings rate over the period from about 1995 to 2007.

Remember that European and US banks are likely to have to raise hundreds of billions of dollars in additional capital over the next say 5 years, or sell assets to reduce balance sheets. In those circumstances, will those banks increase lending to Australian Banks or to Australian governments wishing to fund welfare such as health, education, unemployment and retirement benefits?

Will international banks wishing to accept additional Australian exposure simply lend only to those major resource projects with undoubted export markets such as energy projects and not into general pools of funds in banks unless they are guaranteed by the Federal Government? Might foreign banks only fund their own major companies and their projects in Australia?

Could we face a foreign debt capital strike? Or increased yield requirements?

How can our policy makers address this position without causing a recession, higher unemployment, falling house prices and possibly a bank failure or two?

1. See Table 5 on page 10 of
2. See Wikipedia: Net international investment position