MARKETS SPECTATOR: Stocks booster shot

Expect a long period of low rates to stimulate equities, while foreign money says it's time to buy China.

Buy the rumour, sell the fact

Price action on the Australian market today was a classic case of ‘buy the rumour, sell the fact’. Over the last week, the market was bid higher as expectations of a rate cut encouraged investors to move into equities. Now that that has been confirmed, we’re seeing some profit taking following the strong rally.

This latest move from the RBA confirms our view that interest rates are going to continue their path lower as the central bank tries to kick-start growth in the non-mining sectors of the economy. This will be positive for the equity market as high yielding stocks are re-rated as investors are forced to ditch the perceived safety of term deposits due to a lack of return.

We feel this theme has only just begun as we enter a period where interest rates are going to have to remain low for an extended period of time to counter the contractionary effects of a slowing mining sector.

DeMark indicator flashes buy on Shanghai Composite index

Famed for his software that identifies tops and bottoms in tradeable securities, Market Studies founder Tom DeMark overnight indicated that his software had flashed a ‘buy’ signal on both the sequential and combo charts.

DeMark said that the Shanghai Composite will rally 48 per cent within nine months after its decline below 1960 recently signalled selling has climaxed.

"Everyone is negative on the SHCOMP index, absolutely everyone,” DeMark wrote in an email, referring to the Chinese benchmark gauge’s ticker symbol. "And now is the perfect environment to make a low and be positive as the last seller, figuratively speaking, has sold.”

This view supports what’s been happening on China facing ETF’s and Hong Kong listed H-shares. When talking about the Shanghai Composite, however one must remember that it can only be traded by Chinese residents and is 70 per cent made up of retail investors. Hence the reason it’s viewed as a good contrarian indicator to what is actually happening.

This is based on the premise that retail investors are usually the last group of participants to sell during a bear market, and vice versa.

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Source: Iress

The above chart compares the performance, since June 1, 2012, of the Shanghai Composite, Hang Seng China Enterprises, Guggenheim China Small Cap ETF and iShares FTSE China 25 index fund.

You can easily see the huge underperformance of the Shanghai Composite. In fact, versus their Hong King listed counterparts (H-shares), the Shanghai Composite has underperformed by more than 27 per cent in less than six months.

This confirms the contrarian view because the three outperforming securities above are all open to foreign investment, which indicates that a lot of foreign money believes it is time to buy Chinese facing investments as the economy begins its recovery.

Recently, there’s been a lot of attention about the performance of the Shanghai Composite index, or more correctly the lack thereof as it broke down through and closed below the psychologically important 2000 point level for the first time since January 2009.

And all this has occurred against a backdrop of improving Chinese economic data, with the official manufacturing PMI confirming this further by hitting a seven-month high just a few days ago. In fact, the general consensus is that Chinese growth has now bottomed and looks to be in recovery mode.

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