Let me take you to a sunny beach resort yesterday afternoon – a place where wireless internet communication is poor, but where the general store has an internet terminal for rent. Ignoring the surf is a middle-aged day-trader undertaking his research preparations with great intensity.
He knows that he needs to be ready for today and he made sure the shop would be open early because the charts showed the Dow index of US shares had broken the trend line and was headed for trouble. That means trouble for Australian shares, and I suspect this particular trader might have too many long positions.
Charts have a tendency to be self-fulfilling, but in this case there are also warnings in the world of fundamentals where some analysts are nervous about looming results and earnings per share trends given the major capital raisings. Others worry about China.
A large number of US investors are concerned about the impact the Obama banking restrictions will have on markets.
But this morning I want to focus on a different concern, which I believe may have an important long-term impact on the market.
As I moved around markets last week, I found that one or two leading, well-funded international companies are now having second thoughts about major expansion and/or capital return programs because they can see global signals pointing to a considerable rise in the world cost of money.
Many of these signals are based on research coming from leading investment banks, but at the base of much of the higher money cost speculation is a report late last year from the International Monetary Fund.
The IMF warnings appear to have played a role in curbing the rise on Wall Street during December. What the charts are signalling will always be a matter of speculation, but for those using fundamentals, if we are looking at a global increase in the cost of capital, then it is not good for share markets.
The IMF totalled up all the expansionary plans of the leading countries in the G20 and calculated that government debt will rise from around 80% of GDP about two years ago to 118% of GDP in 2014. And that amazing prediction even assumes some discretionary tightening next year. The IMF says the ideal level is 60% of GDP but to halve debt by 2030 will require an enormous attack by governments on ‘entitlements’ and other spending, plus higher taxes.
It also means higher interest rates. The IMF estimates that stabilising debt at post crisis levels might require interest rates to rise by perhaps 2 percentage points. But higher interest rates further boost debt levels and lower servicing ratios so can snowball to even higher rates.
There are a lot of other possible scenarios, but once the international corporate community begins to assume that the cost of capital is about to rise it can become very infectious.
In the IMF studies, Australia comes out well because our government has relatively low levels of debt. But our banks have not been aggressive enough in seeking local deposits, so our banking system is very dependent on overseas funding. If there is a further rise in the global cost of capital then it will make it tougher for our banks to fund their loan books and cause local business and domestic borrowers to suffer higher interest rates.
Australian households are very highly leveraged, and higher interest rates will affect them severely.
What the IMF is alerting us to is that while governments avoided the global financial crisis by an avalanche of spending they did not match that spending with additional revenue. That means that governments are going to have to borrow large sums later in 2010 and in subsequent years and as they go onto the market, they will push up interest rates – or at least that’s the way some large international companies are seeing it.
This helps explain why Westpac has been offering 8% for five years (2% above what many banks offer for one year) and has been active in securing its overseas borrowings.
The day trader in the general store probably knows none of these things. He can simply smell a market fall.
This article first appeared on Business Spectator.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
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