This article appeared in the May 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Time is on the market's side as global economic recovery makes shares more attractive.
By Rod North, Bourse
There are more signs to indicate that the bear market is a distant memory, yet the sharemarket in terms of the All Ordinaries Index is struggling to move beyond the magic 5000. So far in 2011, it has made several attempts at reaching and passing the mark but struggled to stay above it.
We saw a similar occurrence in 2010, only for the market to drop back to 4700 amid European debt concerns. The real difficulty is seeing the market get well through the 5000 mark and stay there. Many investment strategists concur that the Australian sharemarket continues to be in the recovery phase and 2011 is another year for investors to consider returning to the market.
One of the real issues preventing the sharemarket from gaining a greater level of momentum has been the persistent uncertainty that has surrounded the geopolitical scene – the unrest in North Africa and the Middle East, recurring concerns over European sovereign debt, the rate and pace of the recovery in the US, and the emergence and sustainable position China now has in the world as the second-largest economy, surpassing Japan in February.
It could also be argued that despite a range of Australian listed companies performing well for the first half of the financial year to December 31, 2010 and likely to put in a solid performance for the full year to June 30, 2011, this has not yet played out universally throughout the overall market.
Australian companies continue to take advantage of a range of positive conditions that assist in positioning them for growth in this part of the investment cycle. These include a high dollar (which makes imports of capital equipment cheaper, though hurts exporters); low unemployment at 4.9 per cent for the March quarter, a reasonably stable interest rate environment; high commodity prices; and better-than-expected growth prospects in the medium to long term for Australia’s GDP.
This is despite natural disasters on an unprecedented scale involving cyclones, floods and bushfires affecting key parts of agricultural across many key states. The one bright spot, although a bitter pill for many, has been the breaking of the long drought.
The full effect of these natural disasters on Australia’s growth is yet to be fully played out. The release of key economic data until the end of 2011 will be the pivotal driver on how these issues affect the direction of the overall sharemarket.
The mining and resources sector can still be seen in isolation and continues to be a highlight, driven by strong offshore demand from our key trading partners. This has helped to fuel growth in this sector of the market, with a number of our top 50 to 100 companies playing a big part in moving the index higher.
US market stronger than Australia
Conversely, we have witnessed a strongly performing Dow Jones Index in the US now moving upwards of 12, 600. Recent economic data has been generally positive and one of the key indicators, employment, now under 9 per cent for the first time since the GFC. It is still believed that the manufacturing industry will be one of the main engines pulling the US economy out of its worst recession in decades. The US is the world’s largest economy and all eyes in the months ahead should be firmly placed on monitoring data on manufacturing conditions, construction spending, personal spending, employment, and the all-important GDP.
Interest rates in the US continue to be on hold at 0–0.25 per cent, which is contributing significantly to keeping the Australian dollar at record highs and getting closer and closer to an unexpected level around $US1.10. Our dollar is likely to stay high until we see further positive signs of the US recovery kicking in, which will trigger the US Federal Reserve to reconsider its current monetary policy stance of keeping rates on hold to assist in the recovery process and get unemployment down.
Where are we on the Investment Clock?
We continue to be in the Recovery Phase of the market, which is really one of the most important times in the cycle to consider buying shares.
Based on the Investment Clock, the Australian sharemarket has temporarily stalled somewhere between 8 and 9 o'clock, a period when shares and commodity prices are generally rising and companies report increased earnings. This is a time when companies continue to capitalise on their survival instincts from the recessionary or economic slump and have become more robust and efficient, and well placed to obtain higher earnings much more quickly from growth in their target markets.
This is achieved by better positioning a company for recovery where time has been taken during the Recessionary Phase to cut out the excesses of the Boom Phase and to downsize and consolidate the business. This approach generally results in higher share prices being driven by sustainable and increasing earnings, and bigger profit distribution to investors who were prepared to come back into the market at this stage of the cycle. Often this patience can be rewarded over time when the market is re-entered during the Recovery Phase.
What the Recovery Phase means
The Recovery Phase of the market can still be a cautious and tentative phase that can react quickly by turning from optimism one minute to pessimism the next, as it looks for assurance that the good times are ahead and that some local or international occurrence will not change the course of events and crush the hard-fought optimism that has gradually reappeared. It can often be a day to day, week to week or month to month proposition, as we witnessed for much of 2010 when the sharemarket began and ended the year at around the same level, because too many left-field events affected its performance.
Although we have enjoyed a spectacular recovery in the sharemarket, from its low point of 3109 points in March 2009 to an April 2010 high of 5000, the market then declined to around 4300 before clawing its way back in three attempts to reach and stay above 5000 in 2011.
Analysis of historical sharemarket performance data over 120 years in Australia shows it can take between 36 to 38 months for a market to recover from its low point and then go on to reach, and surpass, its previous high. The fact that the market rose by 60 per cent in a little over 12 months from March 2009 indicated it may have been getting a bit ahead of itself. It also indicates that a significant part of the potential gain in the sharemarket was still ahead for those prepared to take the opportunity and invest.
With an All Ordinaries currently around 4950, the index still has to rise another 1850 points to reach the high of November 2007 – a further rise of 37.4 per cent from its current level. This is not a bad potential future gain to consider if you are prepared to be a participant with some patience.
Based on historical performance data, the market could reach the previous high in 2012 or 2013. This uplift would be worth waiting for. However, one thing that is certain is that not all sharemarket recoveries are the same. As we saw for much of 2010 and with a different, yet similar, effect so far in 2011, local, international and geopolitical factors can play a big part in determining the rate and pace of growth in the market, even if the overall trend might be up.
One of the key drivers of the market to monitor over coming months will be the full-year performance results of companies reporting to June 30. It will be interesting to see if the strong first-half profit results from a number of key companies continue to play out, as this is likely to determine the direction of the market after June 30.
Some analysts argue that we are at the halfway point of the Recovery Phase in the investment cycle. We reached the second anniversary of the bear market bottom in March, and as we have said, history tells us cyclical recoveries normally go for three to four years. This suggests we have a few years to go before reaching the end of the cycle.
Where the sharemarket could finish in 2011
In forecasting where the All Ordinaries could finish the year, many commentators tip 5200 to 5600. Anywhere in this range would be a positive outcome for 2011, based on 2010 being largely uneventful and ending where it began. Some pretty good gains could still come in the remainder of the calendar year, based on corporate Australia being in good financial shape.
The healthy state of many company balance sheets, a marked increase in IPOs, a greater freeing up of capital, more share buybacks being announced (suggesting companies believe their shares are good value), more takeovers, and higher dividend payments, should continue to drive the market forward and move through the Recovery Phase of the Investment Clock.
As in all recovery cycles of the market, uncertainties remain. However, shares are likely to enjoy further gains to the end of the year and into 2012 in my view. They still appear cheap, relative to government bonds. Many investors remain cautious and nervous about the prospects for gains, but often the contrarian view can prevail. Investors will gain more confidence when it becomes clearer that the US and global recovery is sustainable. This will drive more investment into the sharemarket and we are likely to see a significant reversal of investment flows, out of government bonds and back into shares.
The US sharemarket appears to be “in the zone” of the investment cycle and for a period is likely to outperform Asian and emerging markets, where monetary conditions are having to be tightened to head off inflation. In Australia, following the recent release of inflation data, the Reserve Bank could look more closely at the timing of its next move on interest rates as a preventative measure against the inflationary bogey.
However, Australian shares are likely to continue to benefit from the positive lead flowing from the sustained increase in the US sharemarket.
About the Author
Rod North is the Managing Director of Bourse Communications. For more information about the history of the Australian sharemarket, his book, Understanding The Investment Clock - Your Road to Recovery, is available. You can also visit the World's First Interactive Investment Clock to see what lies ahead in the investment cycle.
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