Making up lost time

The investment clock is stuck at 7.30, but shares will tick higher again.

Financial markets remain firmly in the grip of the early stages of the Recovery Phase on the Investment Clock, with economic data for most of the first quarter of 2010 showing improvement in business, consumer and GDP growth.

But the Recovery Phase on the Investment Clock can be a slow and gradual process, often punctuated by significant reversals in the sharemarket indicating that sentiment remains extremely fragile. It can often take five to seven years to move from the bottom of the Recovery Phase at 6 o’clock to the top of the Boom Phase at 12 o’clock.

We have seen a spectacular recovery in the sharemarket from its low of 3109 points in March 2009 to an April 2010 high of 5000. This was an unprecedented rise of 60 per cent and the gains largely focused on the top 50 companies.

Analysis of historical sharemarket data over 110 years in Australia shows it normally takes about 33 months for a market to recover from its low point to go on to reach, and then surpass, its previous high. That the market rose by 60 per cent in a little over 12 months indicates it may have been getting ahead of itself.

We should not expect this pace of gain for the remainder of 2010. However, it is still quite possible the sharemarket could reach the previous high of 6800, in November 2007, sometime in late 2011 or early 2012.

The sharemarket in a Recovery Phase will always be driven higher based on sustained or increased earnings growth from the major listed companies. Many reported significant turnarounds in the first half of the 2009-10 financial year, largely based on measures taken during the global financial crisis to contain costs, focus on the business at hand and improve the balance sheet.

Not until full-year results are disclosed will we really be able to judge whether a company’s earnings are now reflecting an improvement in trading conditions and profitability based on an economy on the mend.

History can provide a guide to what is ahead:

• The average decline of each bear market since 1969 was 37 per cent; the All Ordinaries index fell 55 per cent from its record high in 2007.
• The worst bear market was between January 1973 and September 1974, when the index declined more than 50 per cent.
• The average sharemarket return for the three years directly following the end of a bear market was 62 per cent, or 17.4 per cent a year.
• The average sharemarket return in the six months directly following the end of a bear market was 28 per cent.

Where we are now on the Investment Clock

Based on a backdrop of worldwide financial and economic uncertainty and the fragility of the recovery process, we are likely to remain between 7 o’clock and 8 o’clock for some time – until world economies show signs of improving and the debt crisis and its contagion effects are no longer a threat to the Recovery Phase.

This is the rollercoaster part of the Recovery Cycle, where companies are forced to become leaner and increase productivity. These measures and the slowly improving economy translate into increased company profits and this gradually stimulates share prices to recover. Investors who enter the market at this level often see excellent gains in the years ahead.

The cash rate is expected to end up somewhere between 4.75 and 5.25 per cent in the second half of 2010. In recent months the labour market has stabilised, with unemployment likely to remain between 5.3 and 5.5 per cent.

Australia has managed to weather the recessionary storm better than most industrialised countries, but it will not be immune from catching a cold from its major trading partners still struggling to claw their way back.

Many companies are likely to report sustained or increased earnings after a year and a half of tightening and consolidation in order to be positioned to take advantage of the Recovery Phase. Increased takeover activity can be expected in the second half of 2010.

These are all classic signs of the re-emergence of the early stages of a cyclical bull market.

The 2011-12 financial year offers some real prospects for positive GDP growth returning, assisted by the major world economies recovering. Investors can expect further sharemarket gains well into 2012.

Source

Rod North is the managing director of Bourse Communication. For more information about the history of the Australian sharemarket, his book, Understanding The Investment Clock – Your Road to Recovery, is available. You can also visit the World’s First Interactive Investment Clock to see what lies ahead in the investment cycle.