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How high can the market go?

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One job I’ve always had the intestinal fortitude to have a crack at is predicting where the overall stock market is heading. As a consequence, at least once a year, my colleagues ask me to make my latest call.

Some 24 months ago, I argued that the 7,000 mark for the S&P/ASX 200 Index was a genuine chance. But that was before the Royal Commission into our financial sector in November 2017. That hurt the index’s growth, given that financials make up around 32% of the index.

That curve ball to strike out my 7,000 call was followed by an even more challenging one from an even bigger pitcher than Malcolm, in the shape of US President Donald Trump, who started his tariffs on China campaign in March of 2018.

S&P/ASX 200 five-year chart

Source: nabtrade

To add more pressure on stock players’ confidence, the Fed in the USA was threatening three interest rate rises in 2019, which has been proved to have been a crazy call on where the US economy was heading.

But wait there’s more: a housing price slump and very restrictive bank lending has brought our economic growth rate down to 1.8%.

So the Royal Commission plus a trade war plus rising US interest rates plus a house price slump and less bank lending not only affected economic growth but obviously explained why the stock market went down from August until just before Christmas Eve.

The triggers for the market bounce-back were the Fed’s boss, Jerome Powell, saying he would show “patience” when it came to rate rises. This was interpreted as “rates are on hold and the next move might be down”. The market loved that and by early January, Trump was tipping a trade war truce and we were off to the races,

Our stock market is up over 20% year-to-date and the reasons are the reverse of what took stocks down.

The Royal Commission imposts on banks weren’t as hard as expected. The Fed is likely to cut rates and our RBA has already cut twice. We’re still waiting on an end to the trade war but the market still thinks we’ll eventually see one, as it’s assumed that Donald can’t afford a Wall Street wipe out because of a trade war escalation, which could lead to a US recession.

If you’re long stocks, you have to hope this works out.

 

Economic comeback?

Locally, economists expect a second-half economic comeback, which rolls into 2020. The latest call on our economy by the International Monetary Fund (IMF) says the economy is forecast to grow 2.1% in 2019 and 2.8% in 2020. And these forecasts might not have the benefit of recent interest rate and tax cuts factored in because the cuts are so recent.

Our economy now has two rate cuts, tax cuts, a minimum wage rise, easier bank lending, a lower dollar and infrastructure spending, as well as population growth to help raise our growth rates, which should help profits by the February profit season.

That said, I’d argue our S&P/ASX 200 Index will be driven by Wall Street. So what’s the likelihood that this current all-time high bull market will turn into a bear market?

CNBC recently did an update of an important set of indicators that I’ve watched for some time and has a history of being a pretty good predictor of the future of financial markets.

The market test is called the Citi Bear Market Checklist, which monitors 18 potential red flag issues and as the CNBC headline tells us “…a market downturn is nowhere close.”

Citi’s Bear Market Checklist

Before the year 2000 dotcom crash, 17.5 red flags effectively told investors to: “Evacuate! Evacuate!”

In 2007, 13 out of 18 of these flags cautioned investors to be a little nervous. And you should recall that credit rating agencies weren’t completely transparent about the exotic financial products that brought on the GFC stock market crash. That number of bear market indicators might have been 14 or 15 out of 18, which might have saved many investors from seeing their portfolios smashed in 2008.

So what’s the latest count? Try four out of 18! This means we can look at the all-time highs on the US and local stock markets and be comfortable that the next crash shouldn’t happen any time soon.

That said, I do take issue with CNBC’s headline that “...a market downturn is nowhere close.” I wouldn’t be surprised if a profit-taking sell off or downturn in stocks was just around the corner, but not a crash. If the US President plays hard ball for a few months, Wall Street could retreat but I’d only fear a bigger slump if Mr Trump slams tariffs on the $US300 billion worth of Chinese imports that currently are not tariffed.

 

Breaking 7,000 on the cards

Ruling out a crash and expecting a trade truce before Christmas, I expect our S&P/ASX 200 Index will beat the 7,000 mark, which is only 3% away (at the time of writing). And given a trade truce between the USA and China has to be good for a 5-10% gain, it makes me think a 7,500 level before say March-April is on the cards.

That suggests about a 10% gain ahead for exchange traded fund (ETF)-index players plus dividends plus franking credits! (I had previously written about ETF ideas to ride the market’s recovery).

I can’t imagine Donald Trump not trying for a strong Santa Claus rally that then rolls into the New Year and the following chart shows how good the November to April time period is.

Source: CNBC

However, with the US election campaign to hot up after April, I’ll be taking a more defensive position with my portfolio. And as my colleague Tony Featherstone suggests, we’re approaching a point in the cycle where it makes sense to trim some equities exposure and implement strategies aimed at capital preservation.

Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. This information was produced by Switzer Financial Group Pty Ltd (ABN 24 112 294 649), which is an Australian Financial Services Licensee (Licence No. 286 531). All prices and analysis at 24 July 2019. This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. This article does not reflect the views of WealthHub Securities Limited.