Is the share market a safe bet now?

Let’s get something really basic out of the way right from the start.

The share market, over the long run, generally performs well. You only have to pick a portfolio of what brokers used to call “blue chip” stocks to outperform most other asset classes like bonds and cash.

In addition, like for instance when someone owns property, they receive rental income, if, over time, you build up a large amount of shares, you can earn dividend income. That can be lucrative.

All I’m trying to say is that you’d really have to be throwing darts with a blindfold to not ‘win’ in the share market over the long term… the really long term.

So what if you’re not in it for the long term? What if you have a whole bunch of money and you want to know where to stash it for the next 12 months to five years.

I’m not going to compare the share market to other asset classes here but I will give you a brief idea of what’s happening to stocks right now, and how shares have been performing recently.

Range bound

Have you seen those stock index charts with all the lines on them, and the little figurines that look like candlesticks? It’s called “technical analysis” or “charting”. And it’s actually a thing.

Very smart people are paid to trace a line over a graph to make out shapes and patterns. They come up with all sorts of fancy names for the patterns they create. If it were full proof, everyone would win, but of course it’s not.

Life, and indeed the markets, do follow patterns. The stock market, however, by nature, in the short term, is unpredictable. One scholar once described it as a “random walk”.

What we can do though is describe quite clearly what’s in the rear vision mirror. To that end I can tell you that the S&P ASX200 index has been what’s called “range bound” since September last year.

What does that mean? Simply that it hasn’t moved quite high enough to reach 5,400 index points, nor has it moved much lower than 4,800 points.

Right now it’s around 5,200 points and is inching closer to the top end of that range. So is that a bullish sign, or a signal it’s about to reverse? It could be either, but if the index breaks through the 5,400 level, and holds there, from a “technical” perspective at least, the market could be on the up.

Also read: There’s a lot riding on the fate of the Aussie dollar

 

What’s influencing different sectors?

Let’s get out of this pattern formation business and actually look at the broad themes playing out in some individual sectors. That’ll help us to work out if there is indeed any life in Australia’s stock market.

We can start with the banking sector. Banks make up a large chunk of the index, so their performance is going to dictate a large part of the market’s overall performance.

The banks had a shocking start to the year. The bears finally retreated in March to make way for a bull run for much of the month, but by early April it was looking ugly again. In the last few weeks we’ve managed to see a bit of a lift in the financial sector.

There are two key factors that influence the stock prices of banks: their current earnings performance, and a guess at their earnings outlook.

There’s been suspicion recently that the banks have too much exposure to the mining sector. That was a key reason for their horrible start to the year.

There are also concerns about the banks’ exposure to what’s perceived to be the grossly over-inflated property markets of Sydney and Melbourne.

There’s also a concern that as the cost of sourcing overseas funds increases, banks will have to compete more fiercely for local deposits, which will squeeze earnings.

The big four banks have in the past been sure bets, but over a shorter term horizon… right now I’m not confident about their earnings outlook.

Then there are the mining and energy sectors. Wow, what a roller-coaster ride. Most of the resources stocks were tumbling head over heels from October last year to January this year.

The rally since early February can be pinned on a much stronger-than-expected lift in commodities prices. The spot price of iron ore at the Chinese port of Qingdao, for example, has almost doubled from a December low of $US38.30 a tonne to more than $US70 a tonne.

Crude oil too is up more than 60 per cent since its 2016 lows between January and February.

Will this rally last? Well in my view it all depends on on-going robust demand from China. Just about every bit of literature I read on China talks of a continual slowdown in its economic growth.

There’s no real evidence of a “hard landing” just yet, but a slowdown nonetheless. I’d be sticking clear of the resources sector for the time being.

Finally I’ve selected three sectors I think may be worth watching over the next 12 months: airlines, tourism, and healthcare.

Planes are highly sophisticated, complicated feats of engineering. So it’s surprising that an airline’s stock price is so correlated to just one factor: the price of crude oil (or jet fuel).

It’s certainly the case with Qantas Airways. I suspect we’re close to the end of the recent run-up in the oil price, and that can only be good for Qantas.

The tourism sector is another one to watch. Policy makers are keen to shift the economy’s “engine room” from being resources-fuelled, to being fuelled by education, tourism and consumer spending more broadly.

As the dollar falls to more reasonable levels in the medium term, and more effort is made to advertise Australia as a destination, listed tourism companies could benefit. Over the past 12 months alone, the numbers holidaying in Australia have increased 20 per cent. May that continue!

Healthcare stocks are also worth a look. Australia has an ageing population, the government is likely to throw more money at the sector over the next 12 months, and the aggressive marketing campaigns of medical and pharmaceutical companies are all ‘positives’.

Understanding the market

Rest assured that, more often than not, big intra-day market swings are often related to moves by the herd – and in particular the herd moving large chunks of mining and banking shares (because they make up the bulk of the index). Don’t let that worry you in the short-term.

However, as I mentioned above, there are stocks outside of this pack that might prove quite attractive in the short term.

The market’s biggest problem of late has been earnings*. Companies (possibly due to a lack of confidence) aren’t engaging in capital expenditure (long term spending decisions) as much, and as a result, aren’t producing the sort of earnings growth you might expect.

You can see it in the overall economy too – we can’t seem to shift past second gear. If you can find companies delivering strong earnings growth, or more importantly, are about to deliver growth, then that’s where you want to be.

This is especially the case for relatively short term investment horizon decisions.

*A good way to compare and contrast a company’s earnings is by looking at something called Earnings Per Share (or EPS).

This should not be considered financial advice. It is general in nature only. I have not taken into account your personal financial situation or your risk tolerance.

 

David Taylor is a journalist with the ABC. Before taking up a position with the ABC, David was a financial markets analyst and economics commentator. You can follow him on Twitter: @DavidTaylorABC.