Rallying into Christmas

PORTFOLIO POINT: With rates remaining low and good dividends yields on offer, the smart money is being bet on a continued run-up in the sharemarket until at least Christmas.

So much for the October hoodoo. It took a holiday this year, sparing us the usual carnage, although an unexpected storm by the name of Sandy sent shivers along America’s eastern seaboard, dealt a terrible toll in human life and created its own chaos on Wall Street for two days.

October was the month the domestic market went its own path. As the New York bourse ran out of steam, the Australian market remained relatively resilient. But where to now?

Forecasting is a perilous business at the best of times and a well-known economist once advised your columnist to always err on the side of negativity.

If things turn sour, he reasoned, you’ll be on the money and hailed a sage. Get it wrong and most people, deliriously happy that their investments have risen, either won’t care or would have forgotten your predictions of impending doom anyway. Hence the old joke about economists predicting 10 of the last four recessions.

But let’s throw caution to the wind. There are enough factors at play right now to suggest that the domestic market will continue to move higher as the year end approaches. Granted, that’s less than eight weeks away, so let’s not get carried away with the notion that the bear has been banished, for there is far too much uncertainty in the global economy to comfortably forecast anything for 2013.

Despite the relatively strong run in the ASX200 since early June, rising from a touch below 4,000 to busting through 4,500 a fortnight ago before pulling back, there still appears to be enough gas in the tank for a late season sprint.

Granted, the September quarter was soft for many companies and the December-half reporting season is likely to reflect a tough half. But there has been recent evidence of a lift in consumer activity and, with the tantalising prospect of further rate cuts ahead, consumer demand is likely to get a boost in the lead-up to Christmas. This week's decision to keep rates on hold does not signal the end of the RBA's easing stance on monetary policy.

Rate cuts have a relatively long lag time, and the effects of the current easing will continue to filter through the economy in the first half of calendar 2013 in terms of lowering costs.

So clearly, investors already have jumped in anticipation of better times ahead. There’s no denying it has been a cautious jump, with the focus of defensives, and particularly yield plays like the banks. And a quick look at the ASX 200 during the past three years tends to put the recent optimism into perspective, bouncing as it has between 4,000 and 4,800.

But the game changer is monetary policy. The Reserve Bank changed tack exactly a year ago when it cut the cash rate from 4.75% to 4.5% on Melbourne Cup day, then added a bonus in December to boost Christmas sales. The cuts then, however, were in reaction to the alarming scenes in Europe rather than domestic factors.

It now is focussing on the domestic situation, looking ahead to middle 2013 when the investment phase of the resource boom begins to wind down, and the potential impact that may have on employment, and kick-starting service and manufacturing.

As the RBA continues to ease, the gap between the yields on defensives such as the banks, retailers and Telstra will further widen, attracting some of that $1.6 trillion Australians now have sitting on deposit. Why opt for 4% on a term deposit when NAB shares, for instance, are offering 7% that delivers a 10% fully franked yield?

Australians, like many in the developed world, have opted for safety, still shaken by the dramatic events of 2008 when a great deal of wealth was obliterated by the market meltdown. In fact, we’ve just passed the fifth anniversary of the market peak when it climbed to 6,750.

We’ve turned into a nation of savers rather than borrowers, a trend that still is in full swing according to the latest figures from APRA.

Where once our banks had to fund lending growth by accessing offshore wholesale funding markets, they now have an oversupply of domestic deposits. Deposit growth is running at an annualised 8% while lending growth is cantering along at a mere 5%. That would suggest that the banks themselves will begin to ease deposit rates, with or without central bank intervention.

Some of those savings will look for a more attractive home.

Internationally, we should see some recovery on Wall Street once the presidential election is out of the way and before the reality of the fiscal cliff hits home. It could be a narrow window, though, depending on how quickly the problem dawns on Capitol Hill. More importantly, for Australia, the indications are that China’s economy appears to be stabilising.

Europe remains the international wildcard. While the situation appears to have settled somewhat, the explosive nature of the situation in Greece, and more so Spain, remains a constant threat over global markets and makes any forecast into 2013 a useless exercise.

How far could the domestic market run up until the New Year? The optimists are betting on 5,000. It’s been there, or within a whisker, three times since the financial meltdown, first during the 2009 recovery, then in early 2010 and again early last year.

On each occasion, the strength of the Australian dollar has acted as a wet blanket over the market, depressing international earnings both from exporters and corporations with foreign divisions while stifling the ability of domestic operators to compete against imports.

Unless the dollar eases back below parity next year, any Christmas rally could well cough and sputter as traders return from the summer holidays. But a combination of lower interest rates – increased demand and reduced costs – coupled with some dollar relief will flow directly through to the bottom lines of many corporates after three years of seriously trimming costs.

So while the price earnings ratios of many defensives look expensive on a global basis right now, many are based on forward projections that factor in a dollar at around current levels. On any logic, the currency should ease next year as mining investment slows. But the domestic currency is subject to the whims of far greater forces than mere terms of trade.

So for now, the weight of money argument tips the balance in favour of a continuation of the recent domestic stock rally, at least until Christmas.