MARKETS SPECTATOR: No-brainer rally

Stocks may be in for a bit of a breather as investors take profits, but a continuing flow of money away from cash paints a bullish scenario for high yielding and cyclical shares.

Price action in the domestic market looks relatively subdued today, especially given the gains seen on Wall Street overnight following the latest positive developments in the fiscal cliff saga (although there’s a fair bit of optimism over the cliff already priced into markets).

Since the S&P/ASX 200 index and the S&P 500 hit a low on the November 16, they have gained 4.1 per cent and 3.6 per cent respectively, with the Australian bourse outperforming. Of those 14 trading days, the local market has only finished in the red on four occasions, which is what I would deem a pretty strong snap-back rally following the post-election sell-off.

However, it now starting to feel like – and has been confirmed by recent price action – that the market wants to take a bit of a breather, and maybe even see a modest pullback as traders look to lock in some profits.

The table below gives a sector breakdown of performance since the 16 November low. Not surprisingly, the rally has been led by the typically defensive yet high yielding sectors like healthcare, telecoms, staples and financials.


Source: Iress

While it is not my view, there are plenty in the market saying high-yielding defensives have had their run and it’s now time to book profits and rotate into more cyclical names.

While I do believe there will be some profit taking among these names, I’m firmly of the view that funds will continue to flow towards high-yielding names as returns on cash and other bank products slide lower. I honestly think we are entering a period where interest rates stay lower for longer than what everyone is expecting.

Just to put this into perspective, the latest research suggests that approximately 30 per cent of Australian superannuation funds are now self-managed. Around 30 per cent of those SMSF assets are held in cash while approximately 90 per cent of Australian bank term deposits are of one year or less.

As of late November, the best rate for a one-year term deposit among the big four banks was 4.4 per cent compared to the lowest, fully franked big four bank dividend yield of 9 per cent. Surely this is a no brainer and we’re going to continue to see a flood of money into high-yielding stocks.

Another interesting thing to note out of the above table is the performance of the MidCap 50 Index. It looks like this outperformance is due to investors starting to look outside the large cap names for yield plays, given how much the large caps have already risen. I think this theme will be with us for a while too.

While I’ve only spoken of high-yielding names, not all is lost for the cyclical names. Actually, far from it! The most cyclical names, in my view, are the miners and I think there is scope for upside, especially given the bottoming we are starting to see in the Chinese economy. This has even started to flow through to the languishing Shanghai Composite index, which surged yesterday on rumours of new stimulus packages.


Source: Iress

The above chart shows the spreads between the S&P/ASX 200 Materials Index and the telecoms, financials ex REITs and staples sectors. The materials index is considered one of the most cyclical sectors while the other three are high yielding, defensive sectors.

The downtrends, which represent the periods when the materials sector underperformed, now look to be ending. This is most notable on the red and blue charts, where they have actually broken up above their respective downtrend lines.

So while I expect to see high yielding names continue higher, I think we could also see some of the more cyclical sectors join the party, which would be a pretty bullish scenario for the local market.

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