The Bull Market Continues into 2014 – 15

The last few weeks have seen some significant investment market turbulence and day to day gyrations on both the international and domestic markets.

•   In nutshell – some turbulence and volatility is OK, and none of this is really worthy of serious concern, despite some of the more negative views around.  October has a (limited but notable) track record of being a spook month and that in itself generates some fear and concern.  We would appear to be experiencing a mid level correction – of which we have not had for some time.

It is appropriate to outline more robust argument for this view below.

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The worst of the GFC is now 5½ years ago and apart from some serious wobbles in 2011 with the Greek Crises MKll the investment markets and more specifically the US markets have maintained an upward march.

Those in the hard core traditional economics club have claimed repeatedly that the world will come crashing back down and many people have maintained very conservative investment stance.

The US economic policy was allegedly meant to fail, the withdrawal of stimulus was suppose to trigger major market upheavals (and hasn’t). The impending interest rate increases are also suppose to trigger a major market crash – will they?

How is it possible that 5 ½ years on since the GFC can there still be ongoing growth without a significant correction?

The answer is probably it could and it couldn’t.

I expect at some stage there will be a more significant correction – when it happens it will probably not be major – but will be larger than what we have witnessed in the past few weeks – but a 10% – 15% drop in the markets is likely at some stage. In the mean time there is still potential for the markets to power on until that occurs potentially adding another 10% – 20% over the intervening period.

A number of market commentators such as Don Stammer, Peter Switzer and Shane Oliver outline a set of rational reasons that markets could continue to improve over the next 12-24 months. In no particular order I have collated these thoughts below:

•    The US economy is still growing with the revised GDP figures for the 2nd quarter running at 4% annualised. Unemployment keeps falling and generally each month, with a couple of exceptions, hold solid positive numbers. Additionally each month also revises upwards a previous month’s estimate.   – The most recent September unemployment figures were great and the previous month’s figures were (as usual) upgraded.

•   Economic growth and falling jobless leads to spending and profit increases for companies.

The latest round of US company reports have been on the whole a positive set of numbers with an average profit increase of 9% in the US vs. The expected figures of only 6%.

•   The profits have come from cost cutting – but with increased employment the next round of increases could come from improved sales.

•   Additionally, for many years the companies in the US under invested in capital goods as they sent production offshore – to China mostly. Much production machinery is older than 10 years. At some point newer machinery will be needed, creating a capital goods demand within the US economy. That has significant economic impact because machines are major capital investment – yet to flow into the US economy.

•   In Australia our own company reporting season has seen as follows
-  68% seen profit rises
-  65% increased their dividends
-  54% of companies exceeded expectations.

•    The US currency has risen significantly against most other OECD currencies and has commenced rising against the Australian Dollar. When that happens our exporting capacity will improve and the various non mining sectors of the economy will have a boost. The Australian investment (share) markets will lift in response.

•    A number of traditionally conservative US market commentators have reviewed their negative views – notably Jeremy Grantham – and see a further period of growth before the US (and by implication the Australian markets) are significantly “overvalued”.   At that point a correction could occur – but that might still be more than 12 months into the future. When it happens it will probably only be back to fair value.

•    The much awaited interest rate rise in the US by the Federal Reserve is likely to be so well telegraphed that the first few rises will quite probably be accepted as inevitable off a ridiculously low base and still offering an extremely low rate relative to the real economic growth potential.

•   The latest economic indicators as at End September show both that the 2nd Quarter GDP growth was upgraded from 4.2% to 4.6% and that Consumer sentiment is now at a 14 month high, but still with scope to grow.

•    A paper by Anatole Kaletski ( one of the investment industry’s big picture futurists from the GavKal investment think tank) sees the past 10 years of stagnation in the US as a similar period to other stagnant years that acted to wind up the economic spring followed by substantial growth. (1890’s-1915, 1930’s-1945, 1970’s).

A prolonged period of growth like the 1950’s and 1990’s is anticipated in this set of scenarios, with some periodic pull back at points of over-valuation along the way.

•    On this I agree. Putting aside the September 2001 attack, the US was going into medium term decline due to high costs when China emerged onto the world stage and joined the World Trade Organisation in 2001. This gave them direct access to many export markets with much lower tariffs.

Their low cost manufacturing base was always going to erode the US market share position and hollow out much of the US manufacturing capacity.

Now however, the cost gap is smaller and other issues can influence a decision to manufacture in the US vs China. On many issues a US based manufacturing plant now wins out (including large pools of under employment).  The US dollar is still competitive even with a recent increase, so growth is still quite feasible, internally within the US economy and via exports.

•    Matt Sherwood from Perpetual just recently issued their September newsletter echoing the sentiment of Anatole Kalestski – making a couple of key points that the US markets do not appear to show any particular hubris or over confidence by consumers, and also the cautious private sector debt management approach. Most people are still wary of being caught out by too much debt as in 2007.

His conclusion is that cautious steady growth could see the US markets continue to rise in an unusually extended growth period out to 2020 – with only a modest tightening cycle that would trigger a breather in the growth in the process, but not derail longer term trajectory.

In Conclusion:

The investment markets, including shares and property (particularly in Australia) could continue to improve until a clear short term overvalued point is reached.

A correction in the global share markets including Australia and the property markets (in particular) could be expected to be modest and short – but still in a 10% -15 – 20% range. This would be considered normal after more than 5 years of growth.

However, in the case of the US share markets in particular, the underlying momentum will limit the magnitude and duration of the correction, before resuming the longer term growth trend.

A brewing revolution in energy efficient capital equipment combined with lower energy costs will help propel this growth, particularly in the USA.

How far the markets might continue to rise before and over how long is the biggest challenge for any market forecaster to assess, so the wise approach is to assume it is likely within 18 months and that it will be best to ride it out, since a turning point leading to a resumption of growth could also occur with very little forewarning in the cyclic downturn.