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These are challenging times for investors and wealth builders with stock markets heading south more times than north in recent weeks. Driving this net negativity is the uncertainty of the sub-prime loan problems. And this has raised doubts over the wisdom of remaining long on shares encouraging many players to become more defensive.

Cautiously positive

Regular readers know that I’ve been cautiously positive about the stock market and have been advising nervous nellies to chase seven per cent bank deposit money if they feared losing their gains of recent years. The analogy I’ve been using has been that there’d be plenty of ups and downs but the general trend was still going to be up.

I still believe that, though recent developments have had me doubting myself. That said, I remain in the positive for shares camp.

I’m not alone.
Expert views

In the wake of the Federal election win for Kevin Rudd and Labor, CommSec’s chief equity economist Craig James, evaluated the impact of a new Government in Canberra. It wasn’t a negative one.

“CommSec currently expects the All Ordinaries/ASX 200 to reach 6,800 by the end of the year and 7,250 by June 2008,” he said. “The end year forecast may prove a touch too high given the recent correction and continued uncertainty about the outlook for the US economy and global credit markets but we expect that continued strength of both the domestic and global economies will drive the Aussie share market to fresh record highs during 2008.”

Recent technical reading

Only a couple of weeks ago the Commonwealth Bank’s econometrician and creator of the ‘exuberance indicator’, Dr. Ron Bewley, gave us his latest reading and said it was a great time to buy. He too had a very bullish outlook on where the local stock market was heading by June next year.

Take two

Charlie Aitken from Southern Cross Equities (a rampaging bull broker, often quoted in the media), sees the current question marks over shares from two perspectives.

“On my news screen yesterday two headlines followed each other,” he wrote recently. “The first was, ‘Citigroup shares fall another six per cent' and the second was, ‘FOB Newcastle export coal prices set new record.’”

He argues we’re looking at two worlds right now.

“We have the widely known problems of the US financial system where major banks get capital injections at junk bond rates - I am stunned at the 11 per cent interest rate Citigroup had to pay for short-term capital - and the continued growth of the BRIC economies,” he explained. “Unfortunately, global equity market sentiment is still set out on the US and that is a trading headwind the strong BRIC growth can't overcome in the very short term.”

By BRICs, he means the developing economies of Brazil, Russia, India and China that are driving commodity prices so high and the share prices of BHP Billition and Rio Tinto with them.

However, Aitken believes in the medium-term, the resource story will overcome the struggling US economy story.
List of reasons
I don’t have the 100 per cent confidence of Aitken but I am investing as though I am and here are some reasons why:
  • the US central bank boss, Ben Bernanke, will keep cutting interest rates to save US financial institutions from a massive contraction that would cause a recession
  • the Republican administration faces an election at the end of 2008 and a recession would put a nail in the coffin for the party. History shows that the Republicans have seldom seen a severe economic slowdown in an election year when they were in power
  • China’s growth is driven by government demand supported by a successful trade policy, which sees them with a treasure trove of foreign exchange
  • the US demand China relies on is important but not too important to undermine strong economic growth
  • interest rate cuts in the UK and even Europe could soon happen and that will help sustain economic activity in the face of financial market uncertainty.
The positive story will win

These are tricky times and a lot could go wrong if economic policies are mismanaged but my feeling is that we will muddle through this phase because the positive BRIC story will win through over the negative sub-prime story.

However, a recession will eventually come and I will be on the look out for that unavoidable eventuality in the year or so ahead.

Right now the forward price/earnings numbers for the overall stock market are well below 20, which is when I start getting a little panicky. This is another reason why I’m still looking for good companies that have been over-sold.

Word of warning

One other word of warning in case you’re different to me. I’m investing for the long-term. I buy great businesses with fantastic outlooks and if the market marks them down in the short-term because everyone is spooked or because short-term traders can sell today to buy tomorrow when the share price falls, it doesn’t bother me. In fact, it’s a buying opportunity.

I have houses that I’m glad I didn’t have to sell two years ago and I’m doubly glad about their value today. I have the same attitude to my quality shares.

Published on: Thursday, December 06, 2007

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