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Climbing the wall of worry

The Australian share marketing is threatening the ceiling. Recent positive moves put the 200 index at the highest point since the devastating sell down of 2008. Positive fundamental factors are somewhat balanced by extensive event risk over 2017. The direction of the market over the coming months will be determined by investors’ reactions at this crucial level. And events scheduled over the rest of April could determine that reaction.

The all-time high for the Australia 200 index occurred on November 1, 2007 at 6,852. The post GFC-low occurred on March 9, 2009 at 3,121. It took the next six years to recover to levels a shade below 6,000, spending almost six weeks between March and May 2015 attempting to penetrate that level before falling away. Now the index is back at 6,000 (give or take) and investors are faced with the same challenge. Are the recent gains sustainable? Can the market trade higher, or will it pull back once more?

The RBA board again reflected on the improvement in the international outlook at its most recent meeting. Stabilising growth rates in China, an accelerating US economy, expansion in Europe and signs of traction in the Japanese economy are positives for the local economy, and therefore shares. So far, so good.

However there are significant events over the course of the year that could derail a modestly positive outlook. Three occur before the end of April.

The US reporting season represents a particular threat. Recent outperformance over US shares by the Australian bourse is a long awaited positive. But local investors should not become complacent. If the US market sneezes, Australian investors will catch a cold.

The problem with the US reporting season revolves around lofty expectations. According to Bloomberg, the consensus forecast across the top 500 companies is earnings growth of 9%. Although this is lower than previous estimates closer to 12%, it is high compared to the two quarters of negative earnings reported last year. Admittedly the US economy is in a sweet spot. Growth is accelerating, but interest rates are still historically low and wages (read corporate costs) are contained.

Nevertheless the big miss on March non-farm rolls (98,000, f/c 180,000) suggests potential downside risk. A number of economists were unconcerned, explaining weather factors played a role. If weather affected jobs growth, it may also weigh on company profits. Although the season kicked off last week with JP Morgan and Citigroup, the likes of Johnson and Johnson and Yahoo this week may provide a better guide to the overall economic outlook. If US investors are spooked by what they see, a slide in share market sentiment may infect all regions.

The first round of voting in the French election occurs on April 23. The leading candidate, Le Pen, and the fastest riser, Mercheron, are both seeking a referendum on France’s membership of the EU. A Frexit is a much greater market concern than Brexit. France is in monetary union, and is the second largest economy in the EU. A departure is an existential threat to the Union.

Naturally, should either the hard left or the hard right gain ascendancy in the four runner field investors are likely to dump shares and ask questions later.

The announcement of a snap UK election in June merely adds to the uncertainty. However given the fact of Brexit the threats here loom largest for the UK, rather than the global economy.

Finally there is the Australian CPI data released on April 26. At the moment analysts are divided on the direction of interest rates. Some expect further cuts in the second half of this year, some are looking for rises. The shockingly low read on inflation for Q2 2016 was a dominating factor in the RBA rate cut of August. Market thinking around this read on Q1 inflation is a continuation of the recent uptrend and an 1.5% annualised rate of inflation.

A number well below the forecast will bring immediate calls for further rate cuts, and could be supportive of share prices. On the other hand an annual rate approaching 2% would take cuts off the table, and could batter the market.

None of these risks are a given, and of course developments over the second half of April could see further gains for shares. A sustained move over the 6,000 index level would be a strongly positive event.

However it’s clear risks are rising. The Australian volatility index has lifted from all-time lows below 8% three weeks ago. While still not at historically high levels this sort of move is usually due to one or both of two factors;  increased demand for portfolio insurance, or professional traders bracing themselves. Either way, Australian investors should take note.

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