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Steady as she goes

Adolph Coors III, who was allergic to beer, was the heir to the Coors beer empire—being allergic to beer is bad fortune for many, but it is Sod’s law that someone allergic to beer would inherit a beer empire.

So its ironical, the market, which has been rising for the first half of 2014 in anticipation of an accelerated global recovery is faced with being slapped down by exogenous geo-political events. Point a finger at any part of the globe, and it’s understandable why Janet Yellen, the head of the US Federal Reserve Board, says investors could be complacent about risk. Mr Volatility will soon be back from an extended holiday.

The market’s strength in the face of adversity has been somewhat surprising. And it is likely ‘buy the dips’ will become the in vogue investment strategy.  The consensus is, and you can see the results in the latest US corporate earnings figures (nearly all up), that the global economic recovery will continue – despite hiccups.

The biggest financial battle will between interest rates and earnings estimates. Local forecasters are divided whether the next move in our interest rates will be up or down. Uncertainty is created by the pesky strength of the Australian dollar. But with rates at 2.5% and being geographically far from turmoil and politically stable, the positive currency carry trade is on every day.

My bet is we follow the global trend and rates ease further. At the very least rates will remain accommodative until the long end (10 years) of the US bond market, rises. Probably not until late 2015. Economic recovery in Australia needs further bolstering.  In simple terms as interest rates go up stock prices fall.  Corporate earnings and dividends are a claim on a company’s future earnings stream.

Rising long term rates means economic expansion, lower unemployment, possibly with a hint of inflation. So unless future earnings keep pace with rate rises, a future earnings stream could be worth less money than the present.

Why interest rates in the US will remain low for some time to come is China has been deploying its massive foreign currency reserves, earned by selling goods to the US in exchange for USD, to buy massive amounts of US Treasuries. It seems when compared to their own sovereign debt US Treasuries are the safest bet for China’s stockpiles of Cash. Even if those treasury rates are close to zero. So will the RBA be the odd man out, and raise rates. Highly unlikely.

The market has priced in an economic recovery in the past six months. If momentum of that recovery continues, the market will remain at or edge slightly higher. If the recovery fails the market will sell off.

Key economic pointers are new housing starts and consumer sentiment/demand. Obviously commodity prices are the overarching financial support of our economy.

So steady as she goes is about the best we can expect. Or as Bill Clinton said “It’s the economy, stupid.”

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