Tread carefully, it's all a little fragile

Is the sharemarket's strong start to the year justified by a brighter outlook for companies? Or are stock prices simply rising because the world is awash with cash, in search of a return?

Is the sharemarket's strong start to the year justified by a brighter outlook for companies? Or are stock prices simply rising because the world is awash with cash, in search of a return?

These questions may sound technical. But they are likely to be a key influence on whether the good times for investors can last. At the time of writing, the ASX 200 was up almost 8 per cent in two months, after breaking through the barrier of 5000 points last month.

If profits are on a path to recovery, it tends to suggest the rally in share prices can be sustained. However, if earnings fizzle out, the rally could prove "fragile", as the pundits like to say.

The graph highlights one reason some experts say markets are fragile: there has been a strong correlation between the US's program of money printing and the rise in US shares. Quantitative easing (QE) is where a central bank buys assets issued by the government, such as government bonds. This has the effect of injecting more money into the global system. In the US, the Federal Reserve has ploughed in more than $US2 trillion in this manner in the past few years. Japan and Britain have adopted similar strategies.

Share investors tend to like QE because it floods world markets with cheap money by pushing down long-term interest rates. Australia hasn't unleashed its own money-printing program, but there's little doubt our market has benefited from the increased investor confidence it's created.

Sceptics, however, say money printing is little more than a short-lived "sugar high" for investors. They point out that despite markets applauding the various rounds of QE in recent years, much of the world has remained mired in recession. Also, interest rates are only low because central banks are trying to jolt their economies awake.

So, has Australia's latest market rally been supported by better earnings? Results from corporate Australia so far have been better than expected. After most big companies had delivered their half-year results, Deutsche Bank said dividends were up about 1.3 per cent, and over half had upgraded their expected earnings.

The bank's strategist, Tim Baker, expects earnings and dividends to keep rising this year - albeit slowly - in an environment of lower interest rates.

Banks - which tend to be a bellwether across the entire economy - also say the lower interest rates are finally starting to tempt consumers and businesses into spending more.

However, these improvements come with some big caveats.

For one, Australian stocks are looking increasingly dear compared with stocks overseas. In recent weeks, the overall market's price-to-earnings ratio has risen to almost 15 times annual earnings, which is more expensive than the sharemarkets in Britain and the US.

Also, executives running our biggest companies still appear deeply reluctant to say the recovery is on track.

Vague phrases such as "cautiously optimistic" have been all the rage in the recent earnings season, yet again.

With firms still apparently lacking confidence in the future, many experts remain wary about future share price gains.

Related Articles