There was a little bit of chill in the morning air this morning, but certainly no chill in global equity markets as stronger than expected earnings from many of the world’s largest companies combined with comments from Fed Chairman Bernanke generate ‘goldilocks’ conditions.

What makes me bullish is many of the biggest consumer and industrial cyclical companies in the world are reporting strong earnings growth – Apple, American Express, Caterpillar, Boeing, DuPont, 3M, and even Harley-Davidson!

I genuinely don’t think this is lining up as the third ‘sell in May and go away’ year. This is lining up as ‘buy in May and stay’, particularly in Australian equities.

There really is something Darwinian about equity markets at the moment. It’s a form of ‘natural selection’ where the strong countries and strong companies are taking from the weak. That is completely different to last year when record high correlations saw the weak and the strong perform in tandem.

Get ready for the shift

While that development is encouraging, what comes next is a massive asset allocation shift from fixed interest, but particularly ultra-low yielding government bonds, into equities. The prospect of that asset allocation shift excites me, but particularly in Australia where 10-year government bonds are now at a 61-year low yield of 3.64% (unfranked) and we have an ageing population that needs yield to live on.

That is why Tuesday’s first quarter inflation data was so important. There is absolutely no inflation issue in broader Australia. If anything we are bordering on having a deflation issue. I still think the first quarter GDP number to be released on 6 June will print negative, which when you overlay the small increase of 0.2% core inflation in the quarter opens the door for a very sharp reduction in cash rates.

I think we are on the cusp of back-to-back 50 basis point rate cuts, which would see the cash rate down at 3.25%. That’s still a big premium to the world, but far less restrictive than 4.25% in a low growth, low inflation overlay.

Stocks are cheap vs bonds

You can see why I am BULLISH on the second half of 2012 in Australia and Australian equities. Not only are Australian equities grossly, grossly cheap versus government bonds, but there are clear catalysts for that value to be released.

The heavy underperformance of Australian equities has been driven by three factors: the high Australian Dollar, high yield alternatives in fixed interest, and political risk. I could also add in genuine scaremongering by some of the independent newsletters and unhelpful comments from other respected commentators about equities as an asset class.

But now the Australian Dollar has peaked (its lower than 12 months ago but nobody has noticed), fixed-interest yields have peaked, and opinion polls suggest when an election is called there will be the greatest Federal landslide in Australian history. I can’t stress enough how these three headwinds turning to tailwinds will be for Australian equities as an asset class.

What we are all underestimating is how quickly confidence can return to households and the asset class. Confidence is like a virus.

What to buy

Personally, I think all roads lead to equities in the second half of this year in Australia. There is going to be a giant switch from unfranked fixed interest yield to fully franked equity yield, while those seeking capital growth will chase Australian resource and resource service stocks.

On that basis I really think it’s time to buy listed fund managers, listed asset managers, and dare I say it, listed stockbrokers. Macquarie Group (MQG) reports tomorrow and if they rally post reporting a tough period, it is telling you to wade into the listed asset managers at what is the bottom of the price, volume, inflow and margin cycle.

I have AMP (AMP) in my high conviction list as the asset management play, but we also recommend Perpetual (PPT), IOOF (IFL), Platinum Asset Management (PTM), and K2 Asset Management (KAM). In the banks, obviously Commonwealth Bank (CBA) and National Australia Bank (NAB) have more market leverage via Colonial and MLC than the other two do. The pending bank reporting and dividend season will be solid in Australia and my number one recommendation remains the very cheap NAB.

My high conviction large-cap buy list of AMP, BHP (BHP), Crown (CWN), Fortescue (FMG), NAB, Santos (STO), Seven Group (SVW) and Telstra (TLS) remains a variety of industrial and resource stocks. Some offer high fully franked sustainable yields, some offer strong earnings per share (EPS) growth, some offer both. I don’t think this is about financials vs. resources. Yes, financials have greater yields than resources, but resources have greater growth. To me it’s about equities as an asset class versus everything else.

Of course my call on Australian equities breaking out of the nine month trading range and doing significantly better in the second half can only be right if BHP shares perform. Interestingly BHP ADRs are up at $35.43, while – hold the phone – the US natural gas price has rallied 5% to US$2.08btu. BHP has bottomed and will continue to see short-covering/underweight covering support.

I can see FOMO (fear of missing out) and FONI (fear of no income) breaking out everywhere in the second half of 2012 in Australian equities, yet consensus remains bearish and conservative as do equity valuations.

This will accelerate when the independent newsletters, which have great influence in the SMSF market, fall on their bearish swords.

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. Anyone should, before acting, consider the appropriateness of the information in regards to their objectives, financial situation and needs and, if necessary, seek professional advice.