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Investing
Confounding connections – Aussie market following the US like a dog on a leash
April 17, 2008
Brendon Lau and Peter Sahui, ShareAnalysis
It seems pretty obvious that the Australian economy stands in stark contrast to the US. But judging from the performance of our share market over the last several months, you would not think so. It seems like Australian shares are happy to be led around by their US counterparts like a dog on a leash.
To be fair, it is not only Australian share investors who are taking their cue from the world's largest economy this period, as the major European indices have followed the US even more closely. To put things in perspective, however, over a 15-year period our share market has moved fairly independently from the US. So to say that our markets are always joined at the hip is not really correct. But the same cannot be said about Europe and the US.
Over a 15-year period, the top European stocks have had a relatively strong correlation to the S&P 500 and Dow Jones Industrial Average (Dow). There have been a number of studies done to try to explain why the US exerts such a varying influence over several regional markets.
These studies have concluded that the strength of the connection has something to do with the proximity of these markets to the US and how closely aligned their time zones are. This goes some way to explain why the correlation between our market and the US is statistically weak over a long period.
However, during a severe market downturn, the correlation between our two markets jumps considerably. There are a few probable reasons for this. Firstly, there is some evidence that US investors are fairly active on our market, as the volume on the Australian Stock Exchange drops noticeably during public holidays in the US. When the US markets suffers a sharp dive, it could prompt these investors to sell Australian equities to cover losses in the US. Conversely, during a bull market in the US, investors might have more cash to invest here.
Secondly, the correlation between the two markets could be skewed by the composition of the Australian index. Banking stocks make up a very significant part of the S&P/ASX 200, and the credit crisis has disproportionately affected the financial sector more than others. So while our real economy powers along, our market index could still take a hit.
There are also concerns that a US economic downturn would impact demand for commodities, and since mining stocks also make up a significant part of our index, this US-triggered turmoil could have further implications for our market.
Lastly, there could also be a legacy issue that links our markets, which is captured in the saying, "When America sneezes, the world catches a cold." Even though our economic dependence on the US has fallen significantly over the years, some psychological habits could be hard to break.
Our purpose of highlighting this "on-again, off-again" connection to the US is more than academic; it has important consequences for how investors think about diversification. If you thought you could achieve a better balanced portfolio by investing in Europe or the US, you could find this strategy working less than perfectly during times of economic strife.
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
More articles from this edition of CompareShares:
Superannuation: Keeping super and pension balances safe during market turmoil
Stocks: Big cap stock that defies market sell-off
Commodities: USD gold bull
Fundamentals: It pays to avoid dud stocks
Analysis: The biggest speculative bubble in world history has some unwinding to go
Resident trader: Trading for that big catch
Investing: Have we witnessed the market bottom?
Investing: Confounding connections – Aussie market following the US like a dog on a leash
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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