Investors will enjoy further market rally

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Instreet managing director George Lucas hit the nail on the head at the end of 2012 when he called for a market rally. Now he makes his predictions for 2013:

In the second half of last year, when Instreet called a share market rally, there was no shortage of sceptics. And who could blame them? The macro issues that have dogged equity markets post the GFC – such as slow US and European economies and massive government and private debt – were still very much evident.

But rally it did; the Australian market by 15%. It might have been on the back of small volumes – further evidence of battle-weary investors fearful of another false dawn – but it was enough to see positive market chatter displace negative comment in the media for the first time since 2009, and to allow superannuation fund trustees to sleep a little easier. Suddenly, the world of investment did not seem so bleak.

Instreet firmly believes this share rally will continue in 2013. In saying this we are cognisant of the risks (of which more later), but believe the positives outweigh the negatives. And if Instreet is right, financial planners will begin to see a shift in client sentiment away from capital preservation and towards return.  But, and it’s a big but, not on the scale we saw before the GFC. Those memories are too deeply etched in investors’ collective psyche to be erased by a 15% upswing in the market.

So why is Instreet positive about this market rally? For us, six factors stand out:

  • Investors remain underweight in equities, and as the market rallied in the second half of last year remained on the sidelines, expecting a sell-off. But investor confidence is growing. Investors might have been on holidays, but they had an eye on the market.
  • The Reserve Bank is lending a hand by having interest rates approaching all-time lows, and there is still respectable market commentary that suggests there is the possibility of another 25 basis points (perhaps even 50) cut in official rates by June. Certainly a rise in interest rates seems unlikely.
  • In the all-important US market, we are seeing record inflows into equity mutual funds – some of the largest weekly inflows since 2003. This is not surprising. As individual investors have deleveraged, there is a wall of money that would prefer equities to cash or fixed income. This wall is breaking.
  • It’s not just individuals. US companies have strong balance sheets, and we expect that with improving markets, US companies may invest nearly $1 trillion in 2013 into equity markets for M&A activity and share buy-backs. The Dell buyout is the first off the rank; Apple has over $100 billion of investable cash that has shareholders making noises about paying back some of this cash.
  • There is a glimmer of hope in Japan. The Government is committed to re-inflating the economy, and it gets its chance in April with the appointment of a new Bank of Japan Governor whose thinking is more line with the Government. Certainly we have seen Japan’s equity market perform strongly over the past few months with its stocks still relatively cheap.
  • In China, economic indicators such as domestic freight volumes, electricity output, real estate and seaport cargo are all pointing to a stronger economic turnaround than being shown by the official figures that are still being reported for 2012.

This market rally will not have a discernible impact on the real economy in the short term. But longer term it will. As share prices rise and feed their way back into the system, we will witness more M&A activity, higher business investment (and therefore more jobs), stronger retail sales, and increased demand for home loans.

Market rallies typically precede improving economies by 12 to 18 months as canny investors – institutional and retail – ignore the current economic malaise and look to the future. Market rallies don’t happen in a vacuum.

There are risks, of course. There are always risks. We can identify four, of which three are geopolitical. They are:  

  • The recent escalation of the conflict in Mali (West Africa) was unexpected and has a larger dimension because it directly involves France.
  • Israel has voted and the while mandate is not necessarily to increase tensions with Iran, it remains a flashpoint.
  •  The political tensions between China and Japan could cause serious issues in the Asian region, perhaps even involving the US.
  • There remains the possibility of a European debt flare-up again. The market is less troubled by Europe this year, but some misplaced political policy could easily change this.

But those risks, in our opinion, remain low. And although we don’t expect the market to continue rising in a straight line – there will be ebbs and flows – we are firm in our belief that is not as short-term trend but the beginning of a multi-year climb by the ASX200 that could see it eventually test its 2007 highs.