Bears beware, the bulls are running again

Is it game on? The Australian sharemarket has rallied a remarkable 15 per cent since early June and the mood has decidedly changed. Even though the volumes being traded are still piddling, the spike in the index has put a skip into the step of market professionals. Broker-client conversations are punctuated with bursts of laughter and the impatience to buy stocks before they go higher seems to be back. This has all taken place in the space of a few short months.

Is it game on? The Australian sharemarket has rallied a remarkable 15 per cent since early June and the mood has decidedly changed. Even though the volumes being traded are still piddling, the spike in the index has put a skip into the step of market professionals. Broker-client conversations are punctuated with bursts of laughter and the impatience to buy stocks before they go higher seems to be back. This has all taken place in the space of a few short months.

In the past week I have surveyed 17 fund managers and stockbrokers, and every one of them can see the benchmark S&P/ASX200 racing to 4800 to 5000 points, or up by between 5 and 9 per cent from today.

This view is primarily based on declining interest rates twisting investors' arms to put money into higher risk assets. The big winners from this flow of money during the course of 2012 have been the high-yielding stocks such as property trusts, telecommunications companies and the banks.

In more recent times, though, investors have started to discover the cyclical sectors such as building materials and non-bank financials. There is also emerging appetite for the much-maligned resources sector.

Unsurprisingly, not one of the 17 professionals that I surveyed can see the market rallying beyond this point. From a technical point of view, the Australian market has tried to breach 5000 points twice since the global financial crisis, only to suffer from altitude sickness and start a steep decent.

The other major reason offered by these people is "no E". When it comes to the sharemarket, the "E" stands for earnings, and when a fund manager or broker says there's "no E", they are suggesting there is no earnings growth. One broker from a bulge bracket house commented that stocks have risen more than 10 per cent in recent months and his company has downgraded earnings across the board by 7 per cent.

The bearish sentiment that has dominated thinking for five years re-emerged last week with New York bank Goldman Sachs telling clients the US market was due for another 15 per cent correction before the end of the year. This would be triggered by the damaging impact of the looming fiscal cliff.

Eventually, the sharemarket will only rise over the long haul if companies generate earnings growth. At the moment, stocks are rising because price-to-earnings (P/E) ratios are expanding. This has effectively been the case in the US for the best part of the past 18 months, with the S&P500 index trading on a hefty P/E of 17.5 times historical earnings.

In other words, profit growth in the US will have to resume soon to justify current stock prices. Australia is on the other end of the spectrum, where the P/E for industrial stocks is only 12.5 times.

In Australia, companies from miners to banks to industrials are still telling investors that things are tough and earnings growth is difficult to achieve. The annual general meeting season will confirm this.

First cab off the rank was the property group Stockland. The company's stapled security was hitting 12-month highs before the board revealed at its annual general meeting that residential property conditions were worsening and not improving. The stapled security fell due to the announcement but has seemingly stabilised very quickly, as investors look to a better future.

This negative operational environment does not necessarily mean that we should be bearish about what is going on. The overall P/E of the Australian industrial market could go from 12.5 times to 15 times before earnings growth reappears.

We have only to observe events in the US to understand this scenario in a low-interest rate environment. Likewise, in 1992 the P/E for the Australian market rose to about 20 times as investors bought stocks in anticipation of earnings growth down the pipe.

While my survey of fund managers and stockbrokers failed to unearth overt bullishness about the market, there are some dissenting voices in the public domain.

Richard Coppleson, the author of Goldman Sachs's Australian afternoon report, stated last week that it feels very much like 2003.

In that year the local market bottomed in March and kept rising without a pullback of more than 5 per cent. By the end of 2003, the S&P/ASX200 had risen by 18.4 per cent at the 12-month mark it was up 26.5 per cent and by November 2007 it was a hefty 154 per cent higher.

Backing Coppleson's bullish sentiment is Westpac's chief economist, Bill Evans, who believes official interest rates will remain low for several years to offset the impact of the moderating mining sector. He believes the big winners from this will be residential property and the sharemarket.

To me, the market feels more like 1993. The benchmark All Ordinaries index bottomed in November 1992 after a long recession and a protracted bear market. It rose 67 per cent over the next 16 months on the back of low interest rates. It was only when rates started to rise globally that equities pulled back. For the moment though, let's just see if we can get through the 5000 barrier.

matthewjkidman@gmail.com

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