I did get carried away on Saturday with the stock market rally, adding an extra up day — it was 12 not 13 — but my mathematical mistake aside, the signs are positive for stocks for 2015. However, reporting season, which starts in earnest this week, will have to add to the optimism.
In fact, by the end of the week, we might be able to answer the question: “Can we trust this rally?”
I do but that doesn’t mean that we might not see some profit-taking over the next few weeks. If that happens I will be repeating my post-2009 mantra, which has been “buy the dips.”
But how long will this strategy be trustworthy?
In simple terms, I believe it is a 2015 strategy with potential to roll on into 2016 and even 2017, though we will have to see some promising developments over the course of this year.
These will be the testing points of my underlying belief that stocks can head higher and that we can trust stocks with our precious money!
First, the US economy needs to show that it can keep on growing at around 3% or higher despite a rising greenback and, eventually, rising interest rates. Its jobs number last week was a nice omen.
History says that an economy can endure a few years and a few percentage rate rises before the stock market yields to the appeal of bonds with more attractive yields. That’s a way off and justifies my call that a serious market slump might not even happen in 2017.
That said, the US is the anchor tenant in this global economic recovery story but the troublesome tenant is Europe.
And this is the second important development but it could become the most important. If the QE program recently announced by the European Central Bank actually works to induce economic growth for the Euro zone, then the pieces of my positive puzzle will fall into place. As the world economy picks up momentum, stock price rises would be justified and it will breed confidence that feeds into further rising stock markets.
This could take some time, but as long as the economic indicators after mid-2015 make it possible to believe that QE is working, then we’re off to the races with stocks.
If this does not result and the QE program doesn’t lead to lending, business investment, consumer spending and economic growth, then the ECB’s failure becomes a trigger for a big market sell-off.
The liquidity trap
If a central bank throws money at a problem and the economy does not respond, we have a liquidity trap and it would vindicate the bond market’s current negativity as shown by their low, no, very low yields right now! If we don’t see growth out of the QE program, then the second most important development becomes the most important and I’d be advising to go to cash.
Bond markets can be wrong, and higher than expected economic growth is the best way to kick the bond market’s butt.
By the way, I don’t expect I will be dashing for cash but that’s my brief to watch the signals, read the tea leaves and the crystal balls on the economy and market, so that’s what I do and if the signs turn negative, so will I!
The Greek election result is a negative for my story but Ukraine peace talks progress is a nice plus.
Our closest neighbours
The third important issue is China. A lot of things could unsettle stocks this year — its growth, property prices, the shadow banking system and other unknowns — but I’m not comfortable being negative on the world’s second biggest economy, with a huge trade surplus and a government that can still change the rules to suit itself!
Fourth, I hope Japan can show benefit from its economic expansionary program. Like Europe, the world’s third most important economy, in terms of demand for the world economy, has to beat off its two decades of recession-like malaise.
Finally, I’d like to see oil prices stabilize around the $US50 plus level and even trend a little higher. The key hope is price stability and that will quell nervous markets and provide the cost benefit of lower input prices for businesses, in concert with consumers with more disposable income in their pockets, thanks to lower petrol prices.
The future is bright
If my wishes come true, the dollar heads lower, our stock market picks up nicely, and by year’s end we will be talking about the RBA thinking about an interest rate rise in 2016.
All these scenarios are possible. If they happen over the next three years, then stocks will head higher, even commodity prices will start to recover, interest rates will rise, economic normalcy begins to emerge and eventually the stock market will get too high and drop. But before that we would have made some nice money.
That’s what I want but 2015 and most of these key economic developments mentioned above have to materialize or else I will be talking to you about option B.
I hope I don’t have to talk about option B but until I do, believe in the rally, even if it disappoints at times — markets do that.
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