Running of the market bulls

In June last year, the ASX200 stock index was faltering. It briefly dipped below 4,000 points as fears grew of a sovereign debt default in Europe, falls in commodity prices accelerated and the Chinese economy weakened with fears of a sub 7 per cent GDP growth pace gaining credence. The US economy was yet to gain traction with a recovery from the deep recession.

Domestically, the carbon tax was about to be introduced, economic growth was cooling and the government was embarking on the largest fiscal policy contraction ever recorded with a cut in real government spending of 3.1 per cent in 2012-13.

There were many reasons for investors to be cautious about the outlook for Australian stocks.

Some 16 months later, the ASX200 is at 5,350, some 35 per cent higher in that short time.

An improvement is economic conditions in the eurozone, confirmation that commodity prices are broadly flat rather than in freefall and accelerating Chinese economic growth have all worked to support the market. Huge amounts of liquidity from the world’s largest central banks have also boosted share prices as the cash finds its way into asset prices.

Domestically, the last 18 months has seen almost universally positive economic news, albeit a touch below trend. At the moment, the forward indicators turning are higher and investor optimism has returned. The fact that the unemployment rate remains below 6 per cent and inflation is in the lower part of the RBA target band has also helped to support stocks.

The carbon tax has barely caused a ripple in the economy and the RBA has cut interest rates to a record low which is starting to fuel a lift in the hosing market and consumer demand.

This record low for interest rate settings are a significant positive for share prices. Many investors would think: why get a lousy 3.5 per cent or so with a term deposit when there are many companies offering fully franked dividends of 4 per cent and considerably more, with the prospect of capital gain?

At the same time, low interest rates boost cash flows for business and mortgage holders and are setting the scene for a lift in economic growth into 2014.

For stockmarkets, economic growth is the most powerful driver of returns.

It seems so obvious to say that whenever there is solid or even strong economic growth, firms boost earnings and profits. In turn, this works to validate higher share prices. The opposite is true in recessions when falling profits (or losses) tend to undermine share prices.

The point now, is with the economy poised to lift into 2014 on the back of a strong world and stimulatory policy settings (Wait on the size of the RBA's bang, October 16), the ASX is likely to rise further. How far and for how long are the big questions.

Another 10 per cent or more, meaning the ASX200 at 6,000 towards the end of 2014, is on the cards. Even if the RBA starts to tighten monetary policy next year, the stronger economy should boost the attractiveness of stocks.

While a forecast for 6,000 and more might seem extreme, don't forget the ASX is still some distance away from the peak of around 6,800 points in late 2007. This peak, it must be said, was fuelled by absurd tax breaks for superannuants, an inflationary government spending spree and easy monetary policy. It was a bubble that was only burst by the economic crisis. The recovery forecast towards 6,000 is based more on fundamentals and substance and is therefore more likely to be sustainable.

Adding to the bullishness, most fund managers (especially the self managed superannuation funds) have a lot of cash which can and probably will be reallocated towards the stockmarket. This could have a powerful effect on share prices if unleashed in a short time frame.

While there are obvious risks in forecasting and investing in the stock market, a combination of solid economic growth, low interest rates and plenty of cash are usually positive drivers for share prices. These conditions are in place now – which helps explain the recent gains – but it might also help to support a positive outlook for share prices in the year ahead.

The end point is a forecast for the ASX200 to hit 5,500 early in 2014 and 6,000 in the latter part of 2014, if not before.