The Australian market is likely to follow Friday’s US lead by opening higher this morning. The S&P/ASX 200 index has now rallied by more than 7% from its low in June. The key drivers of this rally have been portfolio repositioning after the announcement of European initiatives as well as ongoing demand for high yielding stocks with reliable earnings streams. Announcements by the Euro Leaders’ summit and the ECB have reduced the potential for a near term crisis in Europe. Investors have reduced some of the crisis premium in equity valuations. There has also been some positioning for a “monetary policy put option scenario” in a low growth environment. Under this scenario failure by economies to generate improved growth over coming months is likely to lead to further monetary stimulus which would be supportive for the valuations of high yielding stocks. If growth rates and confidence do improve, obviating the need for more monetary stimulus, stocks may benefit form an improved earnings outlook. However, further gains based on this outlook may be reasonably limited from current levels. Significant risks remain in Europe. The fact that long term, 10 year Spanish bond yields remain at an elevated 6.91% are a clear reminder of this. Equity markets are likely to need clear evidence of workable solutions in Europe; improving economic conditions and a better than expected profit reporting season for a strong rally to continue much beyond current levels. This sentiment may be reflected today with relatively subdued trading despite a firm opening. In technical terms the S&P/ASX 200 index is in a clear uptrend. The next hurdle for this trend would be to exceed last week’s high at 4330 and beyond that resistance at around 4350. On the other hand, there is significant support for the index at around 4215 and at this stage a break below that level would be needed to suggest any major downtrend was developing.


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