Yesterday, the Australian share market – represented by the S&P/ASX200 Index (INDEXASX: XJO) – made a new record high. The previous record-high we saw was in mid-January when the ASX 200 pushed past 7,130 points. That level was subsequently retreated from over fears from the coronavirus amongst other factors.
But it was 'pedal to the metal' once more yesterday, and today the ASX 200 is sitting at 7,147 points after going as high as 7,190 yesterday.
So why the sudden surge of confidence? Did some big ASX companies report impressive earnings?
Not really…
Did some positive economic data come out about the Australia economy?
No.
In fact, quite the opposite.
So what's going on?
Well, yesterday, we got the news that Australia's unemployment rate has spiked from 5.1% to 5.3%. That indicates weakness in the economy, to put it simply.
But you wouldn't have thought that was the case looking at the stock market, which seems to actually rejoice on this less-than-exciting news. And in a way, it is.
The reason ASX shares went up so convincingly yesterday is because the jump in unemployment means that the Reserve Bank of Australia (RBA) is that much more likely to cut interest rates again this year.
The RBA desperately wants unemployment lower so there is more pressure on wages to rise – which in turn will boost economic growth (which has been pretty stagnant for the last few years).
If unemployment is going the wrong way, the RBA may be forced to use even more of its depleted stock of dry powder (interest rates are now at 0.75%, which doesn't leave a lot of spare room).
What do interest rates have to do with ASX shares?
Perhaps strangely, quite a lot. Warren Buffett has described interest rates as 'gravity' for other assets. If the 'gravity' is turned down, it propels assets like shares (particularly those who pay dividends) and property higher.
Why do you think we had a record year for ASX shares last year? The three interest rate cuts we saw were almost certainly a large factor!
This is due to both an easing in the availability of money and an increased disincentive to invest in interest-bearing investments like bonds and cash that are interest rate-sensitive.
So, what was happening yesterday was the market 'pricing in' another cut to the cash rate – which led to the perverse outcome of the ASX share market jumping on bad economic news.
It sure is a strange world we live in….
