It’s time for cautious optimism

Founder and Publisher of the Switzer Report
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There are many, largely reliable, investment clichés that I’ve picked up – both the easy and the hard way – after 30-odd years of investing and commentating. One that I’ve dug up out of the old mental hard disc is that stock markets go up by stairs, but go down by elevators!

So are we at the start of a new stairway or do we have one more drop to the basement?

With America showing signs that it will dodge a double-dip recession, the answer to this question lies in how Europe handles its debt management.

Here’s what I’ve seen so far to make me go long with the good old USA:

  • Company reporting has been better than expected,
  • Retailers have beaten forecasts, suggesting the US consumer is alive and kicking,
  • The Fed boss, Ben Bernanke has said interest rates will remain virtually unchanged until 2013,
  • There are a lot of buyers when this market is oversold,
  • The latest reading on US industrial output was the strongest in seven months,
  • Jobless claims are falling,
  • Mortgage applications are rising, and
  • The last two months brought big rises in private sector job creation.

On top of that, my local charts guy, Lance Lai from Accountancy Invest, says a bounce in shares is likely.

My econometrician colleague from my University of New South Wales days, Professor Ron Bewley, agrees with Lai. Bewley (who has a special feature in today’s Switzer Super Report on how he handled his investments during last week’s manic market) was chief investment officer for Commonwealth Bank’s private wealth customers. The fact these two agree is intriguing and reinforces my cautiously positive conclusion on markets going forward.

“Lance and I agree for different reasons,” Bewley told me this week. Lai looks at the technical analysis while Bewley looks at his own analysis of thousands of analysts’ recommendations and his own volatility indexes. To me, if both analyses are pointing in the same direction and it coincides with improving economic and corporate profit data, then there’s a strong reason to be cautiously positive.

The very nervous could wait until the Europeans have come up with a more solid plan than the one that came out of this week’s Paris summit between France’s President Sarkozy and German Chancellor Merkel, but European stock markets have become more positive and Italian bond yields are falling. The latter means buyers are buying them! Though, it could be the European Central Bank’s action – that said, it’s having the right effect.

But wait there’s more, and it’s relevant.

Back in April when I talked about the historical significance of the clichéd rule of thumb for the US market ‘sell in May and go away’, I pointed out that Barclays Capital’s Jordan Kotick had revealed that his charts were warning of a tough US summer ahead. This guy has a great strike rate. So what’s he saying now?

Kotick sees stability as the US summer closes. But what about the Fall – as the Yanks call autumn – will stocks fall?

He looks at inter-market relationships, or ‘market thermometers’, for keys to what might happen to equities. And for September, he’s seeing a high chance that the stock market will form a base off which another leg-up could develop.

To prove his argument, he points to three charts. The first is the ratio of emerging market bonds compared with US bonds. It’s been stabilising at low levels and that’s good for the growth outlook for the global economy given the important role emerging economies are playing in propping up growth right now.

The second chart is the ratio of copper to aluminium. This is stable, which is a good indicator that growth in global manufacturing shouldn’t nosedive. The correlation of this ratio with Wall Street is high.

The third is trade between the Aussie dollar and the sterling. It’s sliding, and when this falls, it’s a good sign for growth because our economy is a guide on global demand ahead. This ratio spiked when the market sold off a couple of weeks ago amid overdone recession fears, but it has started to fall pretty steeply lately and so our rising Aussie dollar is a good sign for the global stock market.

All three of the above indicators say risk is coming back on the table for investors. So, if we get no bad news from the left-field – let’s simply call it Europe – then it could be base-building time ahead of a stronger final quarter for US economic growth and share prices.

Mind you, I hope our dollar can stay at current levels so our stock prices can get a bigger lift than we saw last year.

Important information: 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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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