I believe that marginal equities seller is hard to identify, which could well lead to further gapping higher in the right small and mid-cap stocks. Risk was ‘on’ in January as investors snapped up stocks, with metals and mining stocks delivering twice the return of the benchmark index, and selected small resource stocks delivering more again. This has every chance of being the story for the entire year as cyclicals and Asia-facing stocks lead the index as Europe slowly fades from the daily news.

Where to invest

I had a nice lunch with two very proven Australian businessmen yesterday and our discussion simply reminded me that the way to generate the biggest returns is via high conviction, patient capital allocation to a high structural economic growth theme. Very, very few people are great short-term traders, and in markets still broadly obsessed with the next Greek or Portuguese headline, I am convinced it’s time to be a ‘set and forget’ investor with a big focus on Asian growth equities and high sustainable dividend yield stocks. (Telstra (TLS) remains my ‘enhanced cash’ bet).

My number one contrarian view remains that Chinese growth (and therefore sentiment towards all things China) is going to surprise on the upside this year. Right now China bears are easier to find than the captain on a sinking Italian cruise ship, but all the data from China is now surprising on the upside ahead of the leadership handover to Xi Jinping later this year. Most investors are underestimating Xi, a new style leader for Beijing who is already in the US attempting to improve relationships.

Combine this with the fact the Fed continues to attempt to undermine the US dollar by ultra-easy monetary policy and potentially even a third quantitative easing play, and you can see why I believe the place to be invested most aggressively is Australian resource stocks and those who service them.

Under the scenario I believe in for 2012 and post the Fed’s latest comments, I’ve updated my Australian dollar forecast and it now looks likely to test the highs around US$1.10, with a new trading range of US$1.05 to US$1.15 as global money floods into four of the world’s AA-rated banks and one of the last AAA-rated sovereigns in the world.

Anyhow, just remember, the key to everything is sentiment and in my view it’s improving globally and locally. Sentiment drives momentum and January had both.

Challenger (CGF) – Buy

Given Challenger’s leading position in the annuities space, and its growing reputation as a guaranteed income provider, it remains a top pick in the sector. We reiterate our favourable view on its highly successful annuity sales campaign, its strong retail annuity sales momentum, and it being a key beneficiary of market volatility and continued investor unease. We believe Challenger has appropriately repositioned its business to benefit from growth in superannuation and the shift of baby boomers into retirement with new products and a greater distribution reach.

• Wednesday’s closing price: $4.49
• 12-month target price: $6.20 (previously $6.30)

iiNet Ltd (IIN) – Buy

IINet has agreed to acquire Internode for $105 million. We view the acquisition as compelling given the sound strategic rationale, complimentary nature of the businesses and solid yet conservative synergies expected (we foresee network synergies in excess of the $7 million). While the acquisition is not expected to be completed until 29 February, we don’t expect any material hurdles and therefore have included Internode into our iiNet forecasts. Enhanced earnings growth prospects coupled with an improving regulatory settings support our Buy rating.

• Wednesday’s closing price: $2.99
• 12-month target price: $3.75 (previously $3.25)

Mt Isa Metals (MET) – Speculative Buy

Mt Isa Metals started life as a Queensland gold and base metals explorer, but in the past 12-18 months it has shifted focus to gold in Burkina Faso, West Africa. Its first exploration campaign in Africa was very successful and led to the discovery of at least two significant gold deposits. An initial resource for the Nabanga Deposit is expected in March 2012. Mount Isa’s activities are and will be subject to the usual risks of mineral exploration and development in Africa: these may or may not include inadequate infrastructure, difficult or remote terrain, inconvenient weather, inefficient bureaucratic processes, difficulty in sourcing staff and equipment, slow turnaround of assay results, and the possibilities that tenements may not be granted or contracts honoured. The biggest risk is attached to the results of exploration, which also bring the greatest potential rewards.

• Wednesday’s closing price: $0.28
• 12-month target price: $0.42

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.