The Reserve Bank is clearly now back in the mood to fight inflation and the recent decision to rise interest rates confirms that they believe the Australian economy will fare well in 2010. But if their economic outlook is correct, then why haven’t stocks rallied further?
Some months ago I suggested that the path back to the 4800 – 5000 level for the Australian stock market would be relatively easy but that it would then be difficult for the market to rally much past that point. This is because I believed stocks simply fell too far after the collapse of Lehman Brothers and that eventually investors would realise that the world had not stopped turning.
As can been seen from the chart below of the All Ords Index the overall stock market has continued to rally strongly over the last few months. Clearly the trend has been upwards and although there have been some periods where investors have taken profits, generally buyers have been keen to enter the market.
ASX All Ordinaries Index 3 month chart
But the rally on the stock market has probably been more to do with investors moving back into stocks on the belief that the worst of the global financial crisis is over, rather than simply a vote of confidence in the Australian economy. In other words the market is being driven higher because a devastating global recession seems to be avoided and not because of any particularity fantastic domestic economic news.
Remember the All Ords/ASX 200 are still well below the highs of 2007 and although there has been a sustained rally much of this has to do with stocks simply recovering from being over-sold. Many companies are still struggling to deal with the fallout from the credit crunch and next year is likely to be a year of recovery, not rampant growth.
If we look at the stock prices of BHP & CBA over the last few months we can see clearly how relief has pushed the overall market upwards.
All Ordinaries, BHP & CBA 3 month chart
The chart above highlights how Commonwealth Bank (CBA) has out performed the wider ASX All Ords by a significant margin over the last 3 months and despite all the hype about trade with China, shares in BHP Billiton (BHP) have underperformed the wider market although they have still risen by over 10% since the end of July.
What this charts suggests to me is that although the rally in stocks has been broad it is really a rally of two parts. Part one is a strong rebound in financial stocks as investors become convinced that the global financial system has been saved from a meltdown and part two is related more to the overall global economy.
For me part two is more interesting as the Australian stock market will only push significantly higher now if global trade starts growing again. My view is that the relief rally is almost over and for the All Ords/ASX 200 to move significantly past 5000 then we need data that indicates that global economic growth is gaining momentum.
I am not suggesting that stocks will stop rising over the longer term, however I do believe that the prediction by some stock market watchers that shares will rally up near the highs of 2007 this year or early next year will not happen. In fact I doubt we will see the All Ords/ASX 200 anywhere near 6500 even in 2010.
Over the next few months how Australian stocks will perform will largely depend more on companies like BHP rather than CBA. If mining exports pick up and Australian exporters see increased profits then the market will push higher, however if global growth remains weak then I expect it is going to be hard for the market to push much higher over the last quarter of 2009.