The reasons for and against a stock market rally

Founder and Publisher of the Switzer Report
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Thanks to some overdue maturity in Europe, the Dow Jones put on 2.19% over the weekend to wind up at 12,153. The big Wall Street index is now up 4.98% for the year, which is a big effort considering what this year has brought.

The result even raises question marks over all of the doomsday merchants who have scared many long-term investors to the sidelines to be parked in cash. But with our local bourse still down about 9.7% for the year and about 7% for the financial year so far, the big question for us is: can we finish the calendar year in the black?

Now remember that for the past two financial years our stock market has finished in the black. If over this time your portfolio of assets matched the S&P/ASX 200 in returns and you were in an SMSF pocketing full franking credits, you could have made between 8-10% for your commitment to stocks.

By the way, that’s the benchmark you should be thinking about when it comes to assessing the calibre of your portfolio of shares.

So, back to the big question — can we rally into year’s end?

It’s possible, but first, Europe needs to keep coming up with better outcomes such as what we saw this week. I suspect there are forces that are whispering firmly into the ears of Greek and Italian politicians as well as the new team at the European Central Bank. That recent rate cut that surprised experts is a case in point.

Now if we can assume that Europe can put in some decent weeks of positive actions to seriously address their debt rescue issues, then we are set up for a rally.

The Yanks call it a Santa Claus rally and if the US can also deliver some better-than-expected economic and political results then I expect a decent rally that could even push our index into positive territory. That said, the odds of this happening are not short, despite history saying that our American buddies like to splurge on shares ahead of the ‘holidays’, as they call Christmas.

Here are some other reasons for a rally:

  • US weekly jobless claims of 390,000 are now at a seven-month low.
  • Consumer sentiment is the best for five months before the Euro-panic started in August.
  • There’s a general perception that stocks are cheap and that ‘Euromess’ has just spooked investors.
  • CNBC points out: “Corporations’ new equity purchases for the third quarter total about US$110 billion, or a US$440 billion annualised pace — that’s about 4% of the S&P (500) market cap, at an annual rate and so it’s pretty significant.”
  • The fourth year of a US presidency has been good for stocks historically.
  • When the yield on the US 10-year treasury bond is below the average dividend yield for stocks, a 20%-plus year often follows, but we would still be happy if we only get a 10% year!
  • Falling interest rates should soften the Aussie dollar and help foreigners buy our stocks.

That’s the good news. But what could go wrong?

Firstly, one word — Europe.

But what happens in the US ‘Super Committee’ will also start to play a bigger role in market sentiment.

Over the next two weeks, the US Congressional Super Committee has to find $1.2 trillion in deficit reductions for the next 10 years. The bi-partisan committee has until 23 November to come up with the answers, but if they don’t, an automatic pilot series of cuts and fiscal reform will kick in.

With a US election coming up next year, political parties can play silly games and this could hurt the stock market. I’m hoping the Yanks have learnt their lesson from the Europeans but I always doubt the good sense of politicians, no matter where they live!

Me? I’m punting on a rally but I know I am punting; though it doesn’t matter because I always buy stocks I want to hold for the long-term.

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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