Last week I wrote about why the "safe income" theme may never end. When I wrote it I couldn't help thinking "Well that's the end of the safe income stocks then". It was the sort of article that only gets written at the top.
It also prompted a few emails and the question "What could possibly kill the safe income theme"? So with prompting from my friend and colleague Andrew Quin, the Patersons strategist, here are three possible scenarios for the market ahead, one of which includes the end of the safe income theme as we know it.
Firstly, muddling along with Dutch elm disease - the resources engine slows down and other sectors of the Australian economy don't pick up. This is not the best outlook for the market but it is the most likely. Without the Australian economy kicking along, without money in the government coffers, without the Aussie dollar falling over, the market is quickly going to look expensive because it needs a dose of earnings growth to back up the recent share price rises.
Under this scenario the focus on safe income will remain although actually making money will require good stock selection, timing and a willingness to trade. Simply holding safe income stocks will achieve the income but when your capital starts deteriorating 2.5 per cent yields in term deposits are going to start looking good again.
Secondly, a surprise lift in some sectors - this would be best for traders and not great for the safe income theme but not terrible either. It involves miraculous improvement in Chinese growth prospects, the global growth trend or (and most likely) US growth.
If it happens you can forget about your safe income stocks because everyone who doesn't bury their head in the sand of safety will be making a fortune in the resurrection of the currently shunned cyclicals, discretionary consumer and resources sectors.
The problem with this scenario is that it is unlikely or, more likely, will happen only incrementally over a long period in which the whole market including safe income and cyclicals will struggle to justify further price earnings (PE) expansion from here (that means prices going up without earnings going up) and will therefore range trade.
Again, making money will require good stock selection, timing and a willingness to trade. But there is so much money to be made if global growth does kick on that even the safe investor should keep tabs on China and in particular US house prices and US unemployment.
Thirdly, a rise in global interest rates - the one that threatens the safe income theme the most would be a bottom in US interest rates. It would end the safe income theme and reverse the PE expansion in the safe stocks. We got a brief preview of what it would look like last November when the Federal Open Market Committee started to hedge their bets on interest rates.
Suddenly they started talking about raising rates when unemployment got to 6.5 per cent. The resources sector rapidly rallied. It has since petered out but there's nothing to say that the US recovery won't start to gain traction in which case it will happen again.
The lead indicators are US bond yields. In November, they started to rise. Look for that again.
The other obvious clue will be a change in US Federal Reserve rhetoric, they will start to talk interest rates up before they actually move official rates up. Then look for a pull back in quantitative easing, a sure sign that the bottom on interest rates is in.
The stock market hitting record highs also helps, it relieves the pressure on policy and allows the Federal Reserve to relax a little bit. In fact, it may force their hand as Congress starts to ask questions about their aggressive monetary policy causing a bubble in the housing market and the sharemarket.
That sort of discussion is another lead indicator of a change in interest rate trend. If it happened, then our resources sector would fly again, cyclicals (media, builders) would follow and consumer discretionary (retailers) would be close behind. At the same time those banks, Telstra, infrastructure and utility stocks that are all on cyclically low yields and high PEs will suddenly look a lot less safe than we currently give them credit for.