Slow but steady sharemarket rally continues

Despite the future of the global economy still looking uncertain, the Australian sharemarket continues its cautious rally.

By Donald Williams, chief investment officer, Platypus Asset Management

It has now traded on an upward trajectory for over four months, and with noticeably lower levels of volatility. On 5 October, the ASX S&P 200 breached its previous annual high, set in early May, and at the time of writing it remains above this mark.

At Platypus, we think it likely the market will continue to grind higher, for a number of reasons.

Perhaps of most significance, the breadth in the market during this rally – as measured by the number of stocks rising compared to the number declining – has been vastly superior to that experienced during the similarly-sized rally seen early in the year.

During that 400-point rally, between January and May, more stocks declined in value than rose. However, more recently we have seen markedly more stocks increase in value than decline. Based on the breadth measure mentioned above, three stocks have increased in value for every stock that has declined.

Interest rates and the steps being taken by the Reserve Bank of Australia (RBA) are also key. Although the cash rate cut in October was driven largely by fear regarding the potential for renewed weakness in the economy, the cut itself is unambiguously bullish for the stock market.

In our opinion, this is the first authentically pre-emptive rate cut by the RBA during the current easing cycle. The central bank’s concerns over a subdued end to the mining investment boom seem to have overcome its usual hawkishness.

So, the news for equities investors is looking better than it has done for a while. Nonetheless, it remains a stock pickers’ market, in order to ensure opportunities are taken advantage of and problems are avoided as much as possible.

For example, despite the introduction in the United States of a third round of quantitative easing, we remain cautious about the bulk producers. The growth in steel production in China has been slowing for some time, and we see no reason why this trend will change over the course of the next six months.

At the same time, we do not think that the Chinese authorities will try to slow the economy’s transition from investment-led growth to a more consumption-based economy. In other words, the declining rate of growth in steel production (and consumption) is predominately a structural issue that will play out over the next five to 10 years.

In Europe, ongoing weakness is adding a cyclical element to the current weakness but it seems clear to us that iron ore prices will continue to decline for the next two years (as an annual average), regardless of the global growth picture. In fact, the three major iron ore players seem determined to get the price down as fast as they can by pushing ahead with their ambitious expansions.

On a brighter note, we remain unambiguously bullish on copper and gold, although very little else excites us in the commodity space at the moment.

Indeed, we are seeing small- and medium-cap companies as the primary drivers for growth, and they have led the positive performance in our own portfolio in recent months.

We have recently reinvested into the banking sector as we believe that the banks are in the process of being re-rated for a number of reasons, including yield (which is enhanced every time the Reserve Bank of Australia cuts rates) and (relative) earnings certainty. Healthcare stocks are also providing a substantial contribution to outperformance.

If the stock market can continue its consistent performance for the next few months, into the Christmas and New Year period, then it is on a solid footing to continue its upward trajectory into 2013, and hopefully beyond.

promoted stories

SUBSCRIBE TO THE IFA DAILY BULLETIN

News

Business Strategy