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Australia 200 index - unconventional wisdom

Australia 200 index - unconventional wisdom

The Australia 200 share index is in break out territory. Despite specific fears about trade disputes, and general concerns about the outlook for global growth, the local share market is trading at post-GFC highs. Higher portfolio cash levels mean this is a mixed blessing for many investors.

Is it too late to buy shares? The answer to that question depends as much on individual circumstances as it does the market. Investors nearing retirement, or already relying on investment income, may exercise more caution than those with longer investment timeframes and higher risk appetites. However there are both fundamental and technical factors that support potential further rises and a test of the all-time share market high around 6,850.

The chart tells the story. This long-term look at the main market index covers the last fifteen years. Each of the candles on the chart represents a month’s worth of trading. The mountain on the left is the three-year rally and subsequent GFC induced fall. From 2009 there are many fits and starts, but the overall direction of the market is up.

The horizontal lines on the right show the index climbing through important levels. First 6,000, and after the Federal election the market traded past the previous twelve year high near 6,380. Traders call this kind of price action a break-out, and an indication that a test of the next level is more likely than not. This points to a potential move to the high water mark.

No doubt a number of readers have just choked on their coffee. After all, everyone knows that investors should “sell in May, and go away”. Experts around the globe are warning of a coming recession, many blaming the trade dispute between the US and China.

It’s precisely why the recent gains are sustainable, and further gains probable. Market crashes are born in optimism and exuberance, not scepticism and gloom. When investors doubt, maintain higher cash levels, and prepare for disaster, the potential for financial cataclysm is lower. Perhaps the greatest risk to portfolios over the rest of the year is underperforming a rising market.

Doom merchants will always have a reason to justify the sky falling. The latest (and one of the funniest) is the “per-capita recession”. Yes, if you subtract a contributing factor from any data set it gives a worse result. Immigration and population increases have contributed significantly to Australia’s growth for more than two centuries. What value is there in stripping these important factors from the data?

Additionally, there are fundamental forces that speak to the possibility of a higher share market. The more accommodative stance of central banks in general, and the RBA in particular, provides a cushion to the economy. The increasingly dovish RBA stance weighs on the Australian dollar, making local shares more attractive to international investors.

Outperformance from the largest sectors may drive further index gains. Banks share prices are in defensive territory, largely due to the need to deal with misbehaviour identified at the Royal Commission Inquiry. The surprise result at the Federal election is supportive of the broader economy and the finance sector specifically. Changes to negative gearing and franking credits are off the table and this is positive for both the business and investment cases for bank shares.

Resource stocks are looking at potential re-ratings as the most consequential commodities defy analysts’ forecasts. Iron ore price estimates for this year are broadly between US $55 and $75 a tonne. The spot price is above $100. The situation is similar in crude oil, aluminium and gold, especially in Australian dollar terms. When commodity strategists increase their longer run commodity price estimates the impact on share valuations can be dramatic.

The risks of going against conventional wisdom are reputational as well as financial. Many investors would subconsciously prefer to lose with the crowd than risk the ego hit of going against the flow and being wrong. Naturally, investors must make up their own minds. However blindly following the crowd rarely delivers extraordinary returns.

This article first appeared in The Australian Financial Review

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