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Are Australian stocks poised to rally again?

July 13th, 2009 · Greg Atkinson · No Comments

Since the beginning of May the Australian stock market has basically moved sideways and at present there is no clear trend in place.  Eventually a trend will emerge so the question is:  will the Australian share market rally or move down over the next six months or so.

To help answer that question we need to make some assumptions about what the global economy is likely to do for the rest of 2009 and 2010. According to the OECD  (See: Weak recovery in sight but damage from crisis likely to be long-lasting, says OECD ) U.S. economic activity is set to fall by 2.8% in 2009 and grow by 0.9% in 2010;  so we could say that the U.S economy will basically be in pretty poor shape for the foreseeable future and  it is not likely to be the main engine of  the global economy over the next 12 months.

According to the same OECD report, the Japanese economy will only grow by 0.7% in 2010 but this seems a little low as Japan should benefit from trade with India where growth next year is predicted to be 7.2% and China whose economy is set to expand by 9.3%.

Europe appears to be mixed bag with some modest growth expected in 2010  but most major European economies will still be fairly week in 2010. Russia surprisingly enough is tipped to grow by 3.7% and Brazil at 4%,  so if these forecasts prove correct it seems the emerging markets should be getting over the worst of the global financial crisis next year.

Finally the OECD expects that after the Australian economy shrinks by -0.4% in 2009 that it will bounce back and grow by 1.2% in 2010. It looks like the recession in Australia will not be that severe if we have faith in the OECD forecasts.

Basically the OECD is telling us that in 2009 most major economies will contract and that we can only expect modest growth in 2010. The key thing for investors to focus on is that the forecasts for 2010 are more positive than those for 2009,  although the global economy is still likely to be weak. The global economy is unlikely to do exactly what the OECD predicts but it does appear that 2010 will be better than 2009 and that many of the world’s major economies will return to growth, albeit modest in many cases.

As far as the Australian stock market is concerned we need to take all that information on-board as ask ourselves a fairly straightforward question. Are Australia stocks likely to rise or fall as a result of an improved global economy in 2010?

My view is that Australian stocks will rise and a further rally in the order of 20% off the 3800 level would seem quite possible this year. The Australian economy however will continue to struggle and so we need to remember that generally speaking, the stock market rises and falls ahead of the real economy. This is a hard concept for many people to appreciate and often we feel like selling stocks when actually we should be buying. The economy may feel bad but if it looks like things will be better in 2010 then stocks will actually rise well before then.

The Australian stock market pretty much follows Wall Street as we can see from the chart of the ASX/S&P 200 and Dow Jones Industrials Average below.  So if the Australian stocks are to rally we would need either the relationship between our stock market and the U.S. stock market to breakdown and for our market to rally alone, or for U.S. stocks to rally. I suspect the later will happen.

S&P/ASX 200 vs Dow Jones Industrial Average – 6 months chart

sp-asx-200-vs-djia-jul-09

As I write this post stocks have just closed lower in Australia, the European markets are down and the Dow Futures indicate that U.S. stocks are set to open down; so why would I be expecting Australian stocks to rise over the next 6 months or so?

Firstly because the OECD forecasts indicate that next year will be better than this year and if this plays out roughly as forecast than investors will move back into stocks.

Secondly, once we get past the reporting season investors will start to look more to the future. Company profits are down, most companies will report a drop in earnings and a lot of stocks will be sold off by nervous investors…but this is what recessions are all about.  If you believe as I do that the global economy will not spiral out of control then now is the time to think about a stock market recovery and try and be in a position to benefit from that recovery. After a while investors will get over poor company results and focus on outlook for 2010,  if it looks better than 2009 then this will help support stock prices.

And finally the U.S. economy will eventually bottom out and this will come as a relief to markets around the world. Very few people seem to believe the U.S. economy will quickly turn around and so at this stage everyone is looking for signs that the U.S. economy might be stabilising. In world where investor confidence is so low just a hint that the U.S. might avoid a complete meltdown will be enough to give the stock market a kick up.

I am not expecting a surge back to anywhere near the stock market highs of 2007, but I reckon there is more upside in the market now than downside over the next 6 to 12 months. Of course as today’s stock market action shows, there are still plenty of people willing to sell on bad news and therefore the stock market is not a place for nervous investors.

My strategy in the current market is to buy on dips and look for bargain stocks. If I see a particular stock rally strongly then I might be inclined to take profits from time to time, but generally speaking I am more interested in buying when the market is down than selling.

This strategy is not without risk as I am making a big assumption that the global economy will slowly return to growth. In addition it will take around 2-3 years before I really know if I have made the right decisions.  It could well be that in a few years I will discover that I would have been better off just leaving my cash in a bank account!


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