Markets: A market rally in the mix

The S&P/ASX200 index is just 109.7 points away from its high this year on May 14. Since June 25, when the latest rally started, it has gained 9.8 per cent and is now trading at about its 20-year price earnings ratio of 14 times forecast earnings. That is not putting off some fund managers, who see continued momentum for certain stocks and argue the limp domestic economy and, more importantly, disappointing 2013 earnings have already been priced into the market.

The bulls’ story goes something like this: a weaker currency (the Australian dollar is down 16 per cent since April 11) and record low interest rates (the Reserve Bank is expected to cut the cash rate to 2.5 per cent today) will underpin an economic revival that will result in 2014 earnings being better. Deutsche Bank’s Tim Baker reckons sales growth for Australian listed companies will rise between 5-6 per cent on average in the next financial year. Margins will improve, helped by low borrowing costs, while companies are rewarding shareholder loyalty with bigger payout ratios.

Offshore factors are also playing their part. The US economy seems on the road to a recovery, even if it is not expanding as quickly as many had hoped. But that means the Fed is unlikely to take its foot off the gas pedal and scale back its $US80 billion a month ($89.796 billion) bond buying program. Japan’s economy, an important export destination for Australia, may be on the same road of economic recovery as the US, having copied Ben Bernanke’s playbook on QE. China’s leadership, just months into its forecast 10-year term, is unlikely to let its economic growth slide below the 7.5 per cent target. Meanwhile, the spot price for iron ore imported through the north-east Chinese city of Tianjin has risen for the last two days to $US130.20 a dry tonne. The Tianjin iron ore price is up 18 per cent since May 31.

And as for political influences, investors such as Geoff Wilson are looking forward to a potential change in Australian government, which may underpin sentiment further. Wilson is confident the economy will recover over the next 12 months, helped by the prospect of a lower-taxing Coalition government. Although it's hard for Wilson to find companies with earnings growth that have cheap share prices, the WAM Capital chairman says his fund has been buying up in property investment and development company Villa World, whose stock is up 74 per cent in the last 12 months, as well as law firm Slater & Gordon, which has risen 59 per cent in the last year.

For many, the share rally earlier this year was all about the search for yield – and there is still good news on that front. The index’s dividend yield is at 4.26 per cent compared with 3.6 per cent for 10-year notes. That alone may be enough to continue Australia’s long love affair with stocks.