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Why I’m positive now

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by Peter Switzer

Over the past few weeks I put the kibosh on double dip recession talk in the US and the stock market in recent days has supported the optimism.

If the US economy can keep delivering better than expected economic readings or at least not as bad as predicted data then it would put a floor under falls for the market indexes on Wall Street.

This could set us up for a Santa Claus rally which will build on confidence as it will inspire other stock markets and one less problem or question mark will hang over the Oz economy.

The double-dip scenario

To understand the implications, consider the opposite.

Instead of the V-shaped, U-shaped or what I think is a square-root recovery, the Yanks have a W-shaped recovery, which includes another dip into recession. This would send the stock market down and it would mean there would be widespread anxiety on markets, making access to overseas funds more difficult.

Fortunately, the Oz dollar would fall, probably into the 60 plus US cents region — our long average exchange rate is 73 US cents — as the global recovery would be derailed. The Reserve Bank would cut interest rates but CFOs would tell CEOs to cut jobs so you would have a cheaper mortgage but maybe not a job to pay for it.

As a country we would do better than most as China would stimulate its economy again but most other countries, which carry so much debt and have less room to cut on interest rates would be in for a slow grind forward from a period of economic decline.

The optimistic scenario

I prefer the optimistic scenario, which I call the muddle through thesis, which looks more likely. The chances of a double dip have been cut to 20 per cent in the US on a consensus basis.

Is there any proof of better market attitudes?

From March to October 2009 the S&P/ASX 200 rose around 50 per cent and then fluctuated between 4500 and 5000 until mid-April 2010. A sell-off happened and has now been trapped between 4200 and 4600 and if all of this is Greek to you then you would be absolutely right — the Greek Euro-debt concerns was the trigger for this market slide.

Last week we saw the S&P/ASX 200 end at 4638.9, up 0.73 per cent or 33.6 points. However, we are up around 10 per cent since we hit the most recent rock bottom in July.

This market move up reflects less Euro-debt concerns and less chances of a US double dip recession.

Bassanese’s view

For stock market players I like the assessment of David Bassanese’s who’s from the AFR. He uses a market measure called 'market prices relative to the underlying trend growth in earnings'.

The price-to-trend earnings ratio is about 13.5 times but our long-run average is 16.2 times. We got as low as 11 when the GFC spooks grabbed the market but the level is similar to where we were in 2003 before the boom of the noughties.

Bassanese says given the markets dividend yield of 4.1 per cent and assuming trend annual earnings growth of six per cent, if we go back to the price-to-trend earnings ratio of 16 — the long-run level — then that would produce 14 per cent market returns!

Watch US data

So over the next few weeks, US economic data will retain centre stage, but we have to be mindful that a Euro-debt curve ball could also stop us from the home run I expect to see hit before the year is out.

The week ahead

This week the big watches will be:

Overseas:

September 21 US Housing starts (August)
September 21 US Federal Reserve rates decision
September 23 US Leading index (August)
September 23 US Existing home sales (August)
September 24 US Durable goods orders (August) \
September 24 US New home sales (August)

Australia:

September 20 Reserve Bank Governor speech
September 21 RBA Board minutes (7 September)
September 21 ABARE commodity forecasts
September 24 Financial accounts (September quarter)

As you can see, it's a nothing week here but a pretty big week in the States.

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Monday, September 20, 2010