Business News

The investor’s game plan

by Peter Switzer

With Middle East North Africa (MENA) problems retaking centre-stage over the Japanese nuclear threat in the news cycle, an intriguing development for investors has to be Wall Street’s reaction.

The Dow Jones index was up 83.93 points, or 0.71 per cent, to 11,858.52 but was down 1.54 per cent for the week. Meanwhile, the S&P 500 lost 1.92 per cent for the week, when the world waited, anxiety-ridden over the nuclear dama unfolding in Japan.

Those market reactions were extraordinary and shows there is still a powerful inclination for share players to add more risk or equities to their investment assets.

Let’s try and understand why.

Since the high point for the S&P 500 on 18 February, the index lost around 6.5 per cent by mid-last week. That’s a pullback. The Yanks have had two up-days since.

As the AFR’s David Bassanese points out, the correction last April was a big 16 per cent. By mid-week last week we were off around 9.5 per cent and this has coincided with our dollar dropping below parity. This is a reaction to the dual threats to world growth from both Japan and MENA’s impact on oil prices.

Oil outlook

Bob Doll, chief equity strategist at BlackRock says if oil gets to a range between US$120 and US$130 for a sustained time it will hurt economic growth.

The impact on oil from the current issues has meant Merrill Lynch raised their average forecast on Brent oil from US$88 to US$108 but there is a range that extends to US$240 a barrel! That’s worst case.

Six market drivers for 2011

On Japan, BNP Paribas calculates that the disaster will reduce world growth by around 0.25 per cent this year but this could be too low or too high. We don’t know.

If the Japanese and MENA troubles eventually dissipate, then what’s left to drive markets?

First and foremost is the strength of the US economic recovery. Leading indicators out late last week pointed to the ongoing strength of the US economy and that’s despite the fact that consumption as a percentage of GDP is only 55 per cent. Historically, the Yanks were good for 70 per cent of GDP from their spending on consumer goods and services. The GFC has turned the ‘shop until they drop’ US consumer into a saver! This is good for the long-run but is holding back the recovery and that’s why the Fed tried QE2.

The second driver of the market over 2011 is the perception, verified by statistics, that investors want shares. In mid-February before Japan and before Libya went into war mode, a reading of share price movements called the relative strength index or RSI hit 74. Any level above 70 represents an 'overbought' market. When it goes to 30 or below, the interpretation is 'oversold'.

The recent pullback will take the RSI down and Bassanese says as a bull market progresses, investors are likely to buy into dips or pullbacks making them shallower. This is definitely happening in the US.

Third, profits in Australia have run ahead of share prices — quite significantly — and that can’t last. Barring a big profit fall, share prices locally are set to play catch up this year and a falling dollar would help that as well. Foreign investors chase Aussie shares when the currency is lower as it makes shares more affordable to buy using foreign currency.

Fourth, given the above and the fact that the Japanese will repatriate money out of the likes of Australia to bankroll the reconstruction effort, this should push our dollar down over 2011.

Fifth, the market P/E is around 11 and the long run average is closer to 14.5. This adds more weight to the belief that share prices will play catch up with profits this year.

One thing you have to remember is that every year of a bull market there are reasons to sell and get out. The people who got out of the stock market in 2006 after the market went up solidly in the second half of 2002, 2003, 2004, 2005 and 2006, felt like dopes until late October 2007 but after that they felt good about themselves.

Sure we could dip back into recession and Japan plus MENA plus the overhang of debt are all worrying challenges for investors, but the majority of fund managers and investment banks, the Federal Treasury and the Reserve Bank aren’t factoring a major financial market fall or other eruption to derail the belief in global growth and trending upwards markets.

By the way, the experts recognise that 2010 was for stock pickers and small cap companies. However, I’m hearing that this year will be good for big blue chip companies and it should also be good for the index as well.

Finally, REITS are expected to have a good year as well.

Of course, we have to contend with the three horses of the modern economic apocalypse — MENA, Japan and big levels of debts — but if we can muddle through these crises, as we often do, then stock markets should head north especially in the US fall and winter months.

Published on: Monday, March 21, 2011

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