After an indifferent 2014 and a slow start to 2015, the market is currently experiencing one of its strongest breakouts since July 2013. Is the rally which started about mid-January set to continue in the short term, and the question we are all asking is: what can we expect from the Australian share market for the remainder of 2015?
Various commentators in Australia are forecasting an increase in the ASX S&P 200 of between 2 and 16%. There has been much comment on the overall investment outlook focussing on macro-economic issues such as a weaker Australian dollar, weakening commodity prices, bond yields, lower oil prices, the performance of the USA and Chinese economies, Europe, Japan, the performance of our politicians, plus various geo-political scenarios. All these are important to the share market as well as other asset classes.
Our starting point in determining what we can expect from the Australian share market for the remainder of 2015 will be to look at the most important thing that makes stock markets go up – earnings. Factors like interest rates and inflation are also important and will have an impact – because they impact earnings.
Studying the trends of earnings, interest rates and inflation should be a top priority for any investor. These are trends that will reveal the stock market’s true status and clearly distinguish between a flash-in-the-pan rally and a sustainable bull market, or a move in the opposite direction to a bear market.
In this article we will start our analysis by looking at the trend of forecasted earnings growth. Then we will complete our analysis by looking at our Investment Climate System which has interest rates, inflation and earnings as its key components.
As the world leader in both market capitalization and trading volume, the USA stock market will significantly impact other stock markets including Australia’s, so we will start by analyzing forecast earnings for the USA S&P 500. Then we will apply the same methodology to the ASX S&P 200 to arrive at our final view.
Our Forecasted Earnings Growth for the S&P500 is currently at 9.4% pa.
Our Investment Climate System shows that its Earnings Trend Component for the S&P500 has fallen from 1.13 to 1.11 over the last two months. (We explained in detail our Investment Climate System in the last two AIA articles we published at the end of 2014. In summary, a bullish stock market scenario will prevail as long as the Earnings Trend Component is above 1.00—on a scale of 0-2. Warnings of an impending bear market are given when the Earnings Trend Component starts falling towards 1.00 and confirmation of a bear market is when the line falls below 1.00)
This fall in the Earnings Trend Component to 1.11 is not a serious change. Therefore, our view is that a Bull Market Scenario for the S&P500 will prevail in 2015. However we must watch the Earnings Trend Component very carefully. Profits in the oil industry are expected to drop by 16.5% over the coming year, but we expect profits in the consumer sectors to increase from oil’s decrease.
On balance, we believe that once again the USA stock market should do well in the year ahead.
We will now apply the same methodology (but in more detail) to the ASX S&P 200 by looking firstly at Forecasted Earnings Growth and then the Earnings Trend Component of the Investment Climate System for the ASX.
Our Forecasted Earnings Growth for the ASX S&P 200 at 11 February 2015 is 9.75% pa, up more than 1% compared with the same time last year.
Delving deeper into Forecasted Earnings Growth for the ASX S&P 200, standout sectors at the time of this article are Real Estate (13% forecast growth–with 14 companies above 30%), Diversified Financials ( 9% including 16 companies above 30%) and Consumer Staples-Food, Beverage, Tobacco (10%– including 8 companies above 20%)
Turning to our Investment Climate System for Australia, the Earnings Trend Component has fallen from 1.04 to .94 over the last two months, calling us to exercise caution while it remains just below 1.
It is difficult to predict with certainty the way the various macro-economic factors mentioned earlier will play out and affect the share market. On the plus side for the ASX S&P 200, the outlook for the USA is positive. But there is uncertainty on how things will go with China, Europe and Japan. If ASX S&P 200 forecast earnings continue to rise, supported by falling interest rates and inflation, plus positive developments in the various macro-economic factors mentioned, we should see a much better 2015 compared with 2014, with the market up north of 10% by the end of the year.
The Investment Climate System will be able to quickly pick changes in the key drivers of the share market. If there are positive developments in everything we have spoken about, we will see the Earnings Trend Component of the system for Australia quickly move back above 1 again, indicating a good year for the ASX S&P 200. However, if it stays below 1 and moves even lower because of negative developments in macro-economic factors, we will need to actively protect our portfolios.
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