Why the ASX 200 Could Hit 7,000 Soon and 3 Things That Might Stop It

Here is the obvious question for commodity investors, emerging market investors, and…well…all investors: how much further will the US dollar fall and what will it mean for shares? Let’s look at it in terms of the ASX 200.

The S&P/ASX 200 is only six percent away from 7,000. Seven thousand means nothing fundamentally. But it’s an attractive number. And with the market in full bullish cry, we wondered this morning what would have to happen for the market to reach and stay above seven thousand.

It would have to go up 6.43% is the strictly mathematical answer. But that does not tell the full story. The index is up 15% year-to-date. The bottom of the credit crunch sell-off took the index down to 5,671—exactly where it started the year. Where to from here? To answer that, you need to ask what could drive it higher.

The top ten stocks by market cap make up 40% of the ASX 200. Where those stocks go, the index will follow. BHP Billiton (ASX:BHP) is the biggest stock by market cap and has a 9% weighting on the whole index. BHP is up 76% year-to-date. It’s the best performance—by far—of any of the top ten stocks and obviously accounts for a large part of the index’s gain.

The rest of the top ten? Rio (ASX:RIO) storms into second with a 44.6% gain year-to-date. Woolworth’s (ASX:WOW) is third at 26.6% (we should all be so lucky to have Coles as our main competitor), QBE Insurance (ASX:QBE) is fourth at 18% (accomplishing all of that after the 16th of August, when it reached a low for the year at $23.71), Westpac (ASX:WBC) 5th at 17.6%, Commonwealth Bank (ASX:CBA) sixth at 13.4%, Telstra (ASX:TLS) seventh at 5.8%, ANZ (ASX:ANZ) eighth at 5.5%, the Westfield’s (ASX:WDC) ninth at 5.1%, and NAB (ASX:NAB) in last at minus 2.3% year-to-date.

The financials have lagged. A rate cut would be a big boost for the big four banks, and the ensuing rally would easily take the index over 7,000. Or, BHP could storm ahead to AU$50 on the great resource revaluation. The stock is not yet valued like a tech stock. And a report at Miningnews.net this weekend quotes Merrill Lynch analysts forecasting an iron price for 2008 at AU$100.

“Much of the speculation over the likelihood of high iron ore prices has come from reported analysis by Merrill Lynch and J.P. Morgan, both of which reckon that next year’s contract prices for the big producers with the Chinese steel mills will be negotiated at around a 25 to 30 percent increase and Merrill feels even a 50 percent increase or more in contract prices is not out of the question,” reports Lawrence Williams at Mineweb.com

Speculation about the ASX’s performance in the fourth quarter of the calendar year is all academic anyway. Stocks will probably keep rising because there are more local buyers than sellers. Superannuation money continues to flow in. That money has to go somewhere, doesn’t it?

About the only speed bumps ahead between here and 7,000 are further disruptions in the global credit markets, which could shake Aussie confidence, or a sell-off in emerging market stocks and a rally in the US dollar.

Of the last two possibilities, the sell-off in emerging market stocks is much more likely than a rally in the US dollar. “Speculators are increasing their bearish bets against two-thirds of the 50 largest emerging- markets companies,” reports Alexander Ragir for Bloomberg. “That’s making the bulls even more confident stocks will keep rising from Brazil to China.”

In markets past, the trade into high-yielding commodity currencies and commodity stocks was cyclical. Slower global growth reversed the trade and sent investors back into US treasuries and US stocks.

Now, we’re not so sure. The inter-market relationship between so-called emerging market stocks and US assets is certainly not the same as it was in previous cycles. So what is it?

Lacking foresight, we can only say that there is no obvious reason for a rise in the US dollar. This means oil, gold, iron ore and a whole basket of other commodities will rise. High-yield currencies will set new all time highs. And the melt-up in Australian shares should continue.

But don’t forget about the credit crunch. It isn’t over yet. Not by a long shot.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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