The case for and against stocks going higher

Founder and Publisher of the Switzer Report
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A BNP Paribas/AFR survey recently found that 55% of senior finance executives believed economic shocks that rock markets, either locally or globally, are their biggest concerns. Yeah, that’s what most of us expect will happen one day but the “when?” question is kind of important. Our hotshot executives worry it might happen some time in the next, wait for it, 10 years!

I think in 10-year blocks when it comes to stocks because bull markets don’t usually do much better than six years and that’s why Geoff Wilson (of listed investment company WAM) lacks confidence on stocks. He says it’s hard to see value at the moment so unless things change, he wouldn’t be surprised to see a sell off.

(Over a 10-year run, I expect seven good years for stocks and maybe two-three bad ones. I expect a gain of 10% per annum and half of that to come from dividends. You can do better or worse than these historical averages but they have been pretty good in showing up reliably.)

But when I pressed Geoff and said if economic growth here and abroad steps up a level, could that change his perception of good or bad value, he said yes. Similarly, some other market experts think two rate cuts would change value calls but I can’t see that happening. In fact, I don’t want to see it happen as it would mean that our economy is a lot weaker than I’ve been guessing.

Understand this: we need good, no great, economic news to change the equations on value when it comes to stocks. That’s why I continually monitor economic performance and indicators in key economies.

Another interesting survey is the American Association of Individual Investors. Here, the bears are in control, with a 15% spike in negative sentiment to 40.7%. The average of bearishness is around 30%, so this is seen as a big bear story!

However, Charles Rotblut, editor of the AAIJ Journal, thinks bad news can be good news. “Historically when we have seen low levels of optimism, that’s been [paradoxically] correlated with better-than-average returns,” he told CNBC.

Of course, the Yanks are growing pretty well in the mid-2% range and they’ve copped a slowdown via the rising greenback but expectations are that local US companies not known for exporting are set to drive economic growth in coming years.

Meanwhile here, the lower dollar is much better for our economic growth and our recent slowdown has been linked to that sustained period of us enduring a high dollar. Recall even in May, our dollar was over 80 US cents. In case you need reminding, have a look at the 2-year chart for the Aussie dollar:

20150803 - aud-usdSource: Yahoo! Finance

We actually started 2014 in the 90 US cents region, which made business life hard for education and tourism businesses that are now poised to have a nice run. Farmers and miners will cop a windfall gain from a lower dollar but they still will have to cope with lower commodity prices but even these could change over the rest of this year.

Back in the US, the possible September interest rate rise will have the potential to rock markets but some economists think the small employment cost index (ECI) rise of only 0.2% on Friday could delay the first rate hike. Against that, the Chicago Purchasing Managers index (PMI) soared from 49.4 to 54.7 in July and this is an important economic indicator for the US economy.

What is interesting about that ECI reading is that if it worries the Fed being too low then it could wait to December for the first rate rise and that would give our economy a chance to pick up to help our stock valuations.

China has to be a big watch and could affect where our stocks go, after all, demand from China is crucial to the likes of BHP, Rio. And while things don’t look great in China, this (from Bloomberg) has kept me guardedly positive: “Economists at Nomura said this week that China was ‘far from being in a crisis scenario’, and believe the share sell off ‘should only have a limited negative impact on the real economy’.”

Meanwhile, the services sector in China is doing better than manufacturing. As Bloomberg reported: “The official non-manufacturing Purchasing Managers’ Index (PMI) edged up to 53.9 in July, compared with the previous month’s reading of 53.8 and pointing to solid expansion.”

Another big watch issue will be commodity prices, with lower oil prices likely to hurt Wall Street where there are more energy outfits listed, while lower iron ore prices will put pressure on the local bourse.

Some negative analysts think the price of oil could go as low as $US30 a barrel, while others expect OPEC will change its excessive supply game before the year is out, which would drive prices higher.

Chartists are divided but some influential technical commentators see the S&P 500 heading towards 1,970 before swinging around and trending up again. The index is now at 2,103.84, so that would only be a 6% drop. We’re not talking anything like Apocalypse Dow!

This could link to a first rate rise sell off and then, as the lower valuations meet an improving US economy (which we all expect), stocks will spike again.

To me, the bottom line has to be that I keep seeing sufficient economic improvement in the US, gradually in Japan and Europe and, of course, here in Australia.

The dollar’s drop makes me more certain that our stocks will spike, but as I say, we need to keep seeing an economic bang from the many bucks that have been spent on Quantitative Easing worldwide.

If the economic dividend starts to dwindle, then there will be a big stock market sell off and that’s what I’d be trying to tell you about before it’s too late.

As I often advise: “Watch this space!”

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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