I don’t think this rally has legs

Founder and Publisher of the Switzer Report
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The theme I’ve been testing this week on my Switzer program on the Sky Business Channel is one that is near and dear to anyone investing in stocks – can we trust this rally?

Mike Kendall from JB Were is more confident about this market spike than he was a week ago and Lance Lai is comfortable with the Shanghai Composite rising for the past few days, but it is hard to get anyone positively pushing that this rally has legs.

Why? It rests on potential actions of central banks and in particular the European Central Bank (ECB).

Sure the Yanks are sweating on a third quantitative easing package (QE3) from the US Federal Reserve, but there’s a case that Ben Bernanke will hold out as long as he can and might even hope he doesn’t have to use it.

The US economy is doing OK with consumer confidence up, retail sales up in July, the services sector expanding, the housing sector improving and company reporting beating expectations.

Meanwhile China seems to be improving and Rio Tinto’s view on its best customer’s projected growth of 8% yesterday was a nice positive. Today we get new data on Chinese industrial output and other key indicators, but these could still be backward looking. I think the China story looks better as we approach Christmas and that would be a nice gift.

It’s all about Europe

However, Europe is the market maker or breaker. Overnight, McDonald’s reported flat sales, but most of its bad news wasn’t from burger-loving Yanks but from their European operations.

The next time the ECB can take action is tipped to be September and I suspect bond markets could test the ECB’s resolve to do anything real that will make a difference. Spanish 10-year bond yields crept above 7% overnight, which is the worry-level.

This is how Reuters explained it:

“Although the ECB has outlined plans to buy sovereign debt alongside the eurozone’s bailout funds, it will not happen before September…”

There are some who think Spain and Italy could ask for bailout help before. I reckon that’s unlikely but we have a bit of a standoff, which won’t be settled before September. This is a threat to this rally.

Out of puff

I don’t think this rally will keep on marching up and it will be tested, but it – like I have been predicting since March 2009 – will create a buying opportunity to buy good companies at good prices.

This strategy gave us Commonwealth Bank (CBA) at $43 and Telstra (TLS) at $2.53 and even Westpac (WBC), which was around $20 not long ago.

I think the Europeans will come up with something this year, but their procrastination will again test the market’s stamina. It’s not quite at the Brownlee boys’ level just yet!

Bottom line

So I don’t trust this rally yet, but any fall won’t be like August and September last year.

I will be buying on any dip as interest rates are falling, price to earnings ratios (P/Es) are attractive and I’m a long-term investor who knows that the nervousness around now creating attractive share prices will not last forever.

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. Anyone should consider the appropriateness of the information in regards to their circumstances.

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