Once again, the ASX 200 index has baulked at 6000. The reason for the latest failure to clear this important psychological hurdle was the RBA’s decision to leave the cash rate on hold. In a knee jerk response, interest rate sensitive sectors were sold off by disappointed traders, only to recover in subsequent sessions.

The big picture is invariably much clearer without the short-term noise. So, from the obscurity of my poolside lounge in far North Queensland, I quickly realised that nothing had really changed to alter my strategy view other than the headlines.

The big picture

Ironically, all the media releases over the Easter break only confirmed my view that the cash rate is headed lower. Here’s why. In a resource-driven economy reliant on strong commodity prices, China’s growth rate is now expected to fall under 7% per annum. This would be the lowest since 1990. Due to peaking Chinese steel production meeting a large low cost supply response, the iron-ore price has fallen below $US50t. It is worth remembering that only 18 months ago, the iron-ore price was over $US130t. At the same time, the oil price remains 50% lower than 2014, while the coal price is at, or near decade lows. The Australian economy is now experiencing the biggest fall in the terms of trade since records were kept in 1959.

If sustained, this fall in commodity prices is expected to reduce tax revenues by a further $5b thereby increasing the Budget deficit closer to $45b. This would represent a 50% increase from the Budget estimate of $30b in May last year and further delay the expected return to surplus by 2019/20. With a gridlocked Senate, and the government committed to fiscal austerity due to rising Budgets deficits, the economic heavy lifting is being left to the RBA and monetary policy.

The futures market is now pricing in a 76% chance of a May rate cut of 25bp. The terminal rate, which reflects the potential cash rate cyclical low, is now 1.63%. I have been saying for months that the cash rate will have a “1 handle” but I am even surprised at the rapidly changing outlook for RBA policy.

The repeated warnings of frothy house prices are basic RBA jawboning. While residential house prices have risen strongly (mainly in Sydney and Melbourne), they will not prevent the RBA lowering interest rates further. The RBA actually wants a stronger housing market. In the aftermath of the mining boom, housing and construction are the only real sectors genuinely supporting economic growth at present. Make no mistake. The RBA is committed to a lower cash rate in order to orchestrate a lower Australian dollar to encourage a rebalancing of economic growth.

As I mentioned previously, with the most recent cut in the cash rate to 2.25% (which is below GFC crisis levels), it’s very clear that the RBA has joined the global currency wars. Don’t underestimate the importance of this decision. Given the resilience of the Australian dollar around US75-77c, the only way to initiate a further fall in the currency to the RBA’s target range in the 60s, is for another 50bp in rate cuts. The reality is, with fiscal policy on hold and a weakening economy, the RBA simple has no choice.

The cash rate is already at historic lows due to sluggish domestic growth. And against a backdrop of global deflation and ultra-low bond yields, I expect the cash rate to fall further and remain at or low levels for an extended period. In this environment, I continue to believe investors will be forced at the margin out of cash and fixed interest into equities. This is a global and domestic phenomenon.

New trading range above 6000

What comes next in my opinion is the ASX200 consolidates in a new higher trading range above 6000. I already feel my twice positively revised ASX200 trading range forecast of 5700 – 6200 is too conservative.

I feel that because in May I forecast the RBA to cut rates to 2.00% and in the same period I expect NAB, WBC and ANZ to report record earnings and declare record interim dividends. Resources are becoming less and less relevant to the overall direction of the index, due to their declining absolute and relative index weights. BHP Billiton (BHP) is now just 6.47% of the ASX200, while the big four banks combined are 31.5%. ANZ nowadays has a bigger index weight than BHP. You can see why it’s easy to forecast a 6200 ASX200 (and potentially higher) without any help from resources.

The fact the market has baulked at 6000 numerous times is technically bullish. It’s like a build-up and once it takes it out it will take it out strongly (like a damn wall breaking). I like that price action and I think the low end of my ASX200 trading range at 5700 is now too conservative. In a week’s time, the new low end could well be 6000.

And finally, I do realise that many other commentators and fund managers are warning on a lack of value and everything looking expensive. I’m not in that camp because I look top down and globally first.

The real question comes down to tenure. How long is this period of cheap money going to last? My view remains for an extended period and that is why I am happy to remain invested in stocks that may well look expensive versus history, but could become a whole lot more expensive as investors position for more of the same macro settings over the medium term.

The fund manager trade

Back on the 14th of March I wrote specifically on Macquarie Group (MQG) at $75.39. The conclusion was lifting the 12-month price target to $82.50 and reiterating the high conviction buy recommendation.

Macquarie report FY15 earnings on Friday May 5th. While my view on Macquarie is more based on being way above current FY16 market consensus, it is important Macquarie passes the FY15 EPS and DPS test first.

We believe Macquarie will pass that test and both FY15 and FY16 consensus estimates will need positive revision.

Macquarie currently has many strong tailwinds, including:

• Currency movements (primarily A$/US$) since the February profit upgrade suggest a 1-2% upgrade, meaning Macquarie will likely come in at the upper-end of +10-20% NPAT guidance range, and may even exceed this number.
• Macquarie closed several deals late in the FY15 year (US car rail logistics facility in Texas, US equipment finance business – $500 million, $5 billion AWAS aircraft transaction), which will be positive and a boost to next year’s numbers and beyond in the case of the aeroplane leases.
• Markets (and particularly commodities and bond markets) have been volatile and this will benefit Macquarie’s FICC business.
• Capital markets have been buoyant with M&A and capital raisings strong in the 2H15 for Macquarie.

The Macquarie business model is substantially transformed since the GFC, while the annuity-style business contribution to operating income has nearly doubled since 2002, the transformation has never been more apparent – rising from around 20% in 2008 to 60% in 1H15 and generating higher incremental ROE. The correlation between share price/dividends and de-risking, especially since 2011, is also significant.

Let the winner run

As a fund manager, Macquarie remains undervalued: resist the temptation to take profits. This is a classic example of a stock that is in an earnings upgrade cycle yet there is also a concurrent P/E re-rating cycle to reflect the growing forecastability of earnings and dividends due to the increase in annuity style earnings away from the lumpiness of investment banking fees.

ROE is also rising and P/E is a function of sustainable ROE in my opinion. An 18% ROE could well equate to a forward P/E of 18x for Macquarie.

If my EPS forecast of 550c for FY16 for Macquarie proves correct, which would see an ROE of 18%, then, all things being equal, the market would pay 18x for that EPS stream. 18x 550c = $99.00 price target.

My point is it is very easy to see scenarios where Macquarie is a $100 stock. In fact I would argue in these macro conditions, it’s just a matter of when.

Macquarie remains a high conviction buy. Macquarie will be one of the stocks that leads the ASX200 to 6200. Let this winner run.

Important: 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. Consider the appropriateness of the information in regards to your circumstances.