MARKETS SPECTATOR: Rate cut remedy

The local market continues to strengthen as investors price in a snip at tomorrow's Reserve Bank meeting, while US sentiment looks to be on the rise.

In a week that is set to be dominated by data flow, the market has got off to a very good start. After opening modestly firmer this morning, the buyers have continued to bid higher despite the weaker-than-expected retail sales and manufacturing index data. In fact, this data has just added further fuel to the call for an interest rate cut tomorrow, which markets look to be factoring in now.

While there’s no such thing as a sure bet, tomorrow’s rate decision is as close as you’ll get to a done deal, with markets and the bulk of economists forecasting a 25 basis point cut. The Reserve Bank really has no choice given the sharp contraction we’re witnessing in the mining sector and an east-coast economy that urgently needs a shot or two in the arm.

On top of this, the Chinese non-manufacturing sector and HSBC Final Manufacturing PMI both came in slightly ahead of market expectations, confirming the reading we saw on Saturday that showed manufacturing PMI had climbed to a seven month high.

This comes on the back of a solid performance last week that saw the S&P/ASX 200 book a rise of 1.8 per cent. In fact, the last two weeks have seen the market post the biggest two week gain in 14-months of 3.7 per cent, just behind the 4.1 per cent rise in the S&P 500.

Mood in the US has changed

The final two trading sessions in the US last week gave us an insight into how US sentiment has changed. A few weeks ago, the market would have been sold down heavily following negative comments on the progress of the fiscal cliff talks.

However, during Thursday and Friday’s US sessions, markets briefly reacted negatively to the comments before recovering all of the lost ground. What this shows is that markets aren’t being completely driven by just the fiscal cliff headlines and that participants are instead focussing on the underlying improvement seen in US economic data.

Another very interesting theme at play is something dubbed the bear paradox, which is adding a lot of buying support to US equity markets, especially after a pullback. Whilst the Australian equity market has always been among the highest yielding in the world, US equities have never really been known for the dividends they pay.

In fact, it has long been said in the US that if you want income, buy a bond. However, with bond yields at such incredibly low levels, this saying no longer holds true. What we’re seeing now is that the yields on stocks are starting to look attractive when compared to bonds, especially after any kind of market correction.

The more stocks decline, the higher dividend yields go relative to yields available on bonds. As the spread between stock and bond yields widen, money starts to move into equities to take advantage of the higher yield on offer, which in turn starts the recovery in equities.


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