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Will Europe ruin this year’s Santa Claus rally?

As we close in on the end of 2011, we look primed for a possible big finish on the stocks front with Americans historically inclined to create a ‘Santa Claus’ stock market rally. However, the question is, will the Europeans ruin Christmas for all of us?

I’m betting ‘no’, with one of the greatest kicks in the pants for Europe, its squabbling finance ministers and other grandstanding politicians, being the near collapse of the Belgian-Franco bank Dexia. That scare has given the debt solution some momentum.

There will be a series of European meetings over Greece and the expansion of the region’s bailout fund – the European Financial Stability Facility (EFSF) – that could trip up the market; but I believe it’s now clear to all European finance ministers that for the sake of global financial markets and then the underlying world economy, they can’t play a self-interested game.

Even the Slovaks, who made a point of voicing their anger at the Greeks by voting down the proposed expansion, are expected to tow the line and approve the measure by the end of the week.

Meanwhile, the economic outlook is improving over in America, as I’ve been predicting, with the Philadelphia Federal Reserve president Charles Plosser (who has opposed much of Fed chairman Ben Bernanke’s monetary stimulus programs) predicting that the US will grow by just under 2% this year and up to 3% next year. That’s sufficient progress to help stocks go higher.

On top of that, Goldman Sachs recently raised its US growth forecast for the third quarter of 2011 to 2.5% from 2%, blasting recession fears out of the water (at least for now).

This also followed news that the number of jobs created in the US in September rose by 103,000, which was better than the 40,000 expected by economists.

So things are looking up!

Having said that, I agree with some of the bear forecasters when they say that stock markets will find it hard to reproduce the great annual increases of more than 20% that we saw in the years leading up to the 2008 crash.

However, good quality companies known for paying dividends, could easily return a portfolio average dividend of around 5% and if you add in the 2-3% from franking credits, this return climbs to about 7%. So even a tepid market gain of 4-5% means we can hope for a 10-12% gain from stocks in ‘okay years’ and maybe 5% or so in bad years, which compares well to term deposits.

For Wall Street in the year ahead, two arguments make me think 2012 will be alright for stocks. First, as the Presidential election in November looms, history says stocks go up in the fourth year of a presidency.

Also, Stan Stovell from Standard & Poor’s has shown that when the collective yield of the S&P 500 has been greater than the yield on the 10-year US Treasury bond, the stock market on average has gone up 20% in the following 12 months.

Locally, I suspect the Reserve Bank of Australia will cut interest rates in November. I think only surprisingly strong employment and inflation data will stop the bank throwing out a lifeline to businesses, the economy and home loan worriers.

This will keep a lid on the rising dollar and help the slow part of the Aussie economy and encourage foreigners to look at buying local stocks.

The US growing better than expected, Europe getting its rescue act together and our economy enjoying lower interest rates plus a relatively weaker dollar, makes for a great cocktail to encourage some celebrating from stock market investors.

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