Our technical trading expert, Murray Dawes, would say the Aussie index is back at the point of control.
That’s fancy technical analysis talk to say the index is halfway between the top and bottom of the recent high-low range.
That’s always a difficult time for investors. Do you follow the trend, hoping the share market will go higher? Or do you bet on this being the end of the trend and cash in your chips?
Well, if you believe the US market still leads the way on stocks there may only be one answer…
The Financial Times reports:
‘After a shortlived drop last month, US equities have rebounded smartly, propelling major benchmarks to record peaks this week.
‘The move has been accompanies by robust flows into US equities, with more than $2bn per day being pumped into exchange traded funds alone so far this month. Putting this into perspective, US equity ETFs in July are currently attracting nearly four times the inflows we saw during the first half of the year.’
There is always some correlation between the US and Australian markets.
Sometimes it breaks down for a short time, but the link soon resumes. Take the six weeks from mid-May. US stocks fell about 6%, while Australian stocks fell 10%.
And yet, since both markets bottomed out in late June, each has rebounded in lockstep — the US stock market has just hit a new record.
Put simply, whatever short-term hot topics burst on the scene, one thing is clear: as far as markets are concerned, the US still leads the way and the Aussie market follows…
At the moment, the companies in the S&P/ASX 200 index are trading at a price to earnings (PE) ratio of 13-times. To put that in context, that’s around the 10-year market average.
Now, some folks will say that’s proof the market is about to fall. After all, if the market trades above the average then it must be over-priced. You wouldn’t believe the number of times we see that line trotted out…usually by people who clearly have no understanding of the concept of averages.
An average is always somewhere between the high and low point — that’s why it’s an average. That means if everything lines up as we hope, stocks could still go higher, especially if Aussie stocks perform better than the market expects.
But there’s also something else to consider, and that’s the likely further downward trend of Aussie interest rates.
When interest rates were higher, investors would have a set limit on the amount they’re willing to pay for a share — historically around 13-times earnings. They knew if they paid more it would impact their returns compared to other investments — say, bank deposits.
But now, interest rates are lower. That could cause investors to pay more for stocks. If so, it could push PE ratios higher…and therefore share prices too.
We understand it’s a risky argument. It’s fair to say most investors still haven’t got the hang of it because bank savings rates are still above 4%.
But if savings rates drop below this level, that could put a different spin on things.
Even without that, there’s reason to be optimistic about stocks. Remember, the stock market is always a forward-looking indicator. The big institutional investors are always thinking about where companies will be in the future, not where they’ve been in the past.
That explains why Australian stocks are still 40% below the 2007 peak. Investors have built in a whole lot of (justified) negativity. And now they’re waiting for that negativity to pass.
Here’s the thing. Remember what we said, investors are looking ahead. They’re trying to figure out how good (or bad) the economy will be 12 months from now. Based on the recent performance of the market, most investors aren’t that optimistic.
If they were optimistic, stock prices would be much higher. The fact they aren’t tells us that most folks have already factored that into the market.
So when you start to see positive news return, you better be ready to be a part of it, because stock prices could take off in a flash. In fact, odds are stock prices will start rising before that as investors look for ‘green shoots of recovery’.
Look at the US market. No-one in their right mind would suggest the US economy is sitting pretty. Detroit has filed for bankruptcy, and the US Federal Reserve is still printing billions of dollars each month to buy government bonds.
And yet US stock prices are at a record high. Why is that? That’s right, investors are looking ahead. They’re looking ahead to low interest rates, more money printing or an economic recovery…or all three.
None of this is to say the Aussie and world economies are without problems. If you’ve read Money Morning for long enough you’ll know we disagree with all forms of intervention in the markets.
But we also know that whether we agree with it or not, and regardless of the long-term impact, intervention and artificially low interest rates do help stock prices in the short term.
So if your goal is to make money from investing (whose goal isn’t?), it’s important to understand this and exploit it. If the US market can hold near these highs into the end of the year it could be the spur that takes the Dow Jones Industrial Average towards 20,000 points.
And if the US market takes off, there’s no doubt in our mind the Australian share market will follow. The time to buy stocks is when few others are positive about the future…that’s now.
Cheers,
Kris+
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