Betting on Stocks

Today, we close the loop on the possible causes and motives of the current stock rally. The All Ords are now up 6.2% for the year. It’s been the task of this week’s Reckoning to figure out what’s going on. So let’s explore the last and admittedly most obvious possibility: the future.

It’s commonly said that stocks lead the economy. Investors shouldn’t be focused on last quarter’s earnings or even this quarter’s. It’s the next six and twelve months we have to think about. If you think about the next year and feel pretty good about it, odds are you’re going to buy stocks today.

This position requires you to believe that the global economy is getting better, not worse. It requires you to believe that the worst of Europe’s debt problems are in the past, and that America’s economy is on the rebound, even if its fiscal situation is still cloudy. But mainly it requires you to believe that bull markets are born out of uncertainty and that the biggest gains are made by the bravest investors.

Still, it’s hard not to think that capital flows from Japan are involved. In fact let us present one final piece of evidence in the case for Japan leading the Australian share market higher. The chart below shows the price performance of the Nikkei 300 and the All Ords over the past year. It shows most of the same elements our previous evidence has showed. What does it show?

Nikkei 300 and the All Ords over the past year

Source: StockCharts


To the Markets and Money eye, this chart shows that stocks are an anti-cash, anti-inflation position. The lower real and nominal interest rates get, the more attractive stocks as an asset class look, at least on a relative basis. It also shows that recent Yen weakness has led to higher Japanese stock prices (the red line). Aussie stocks have not yet followed with the same degree of enthusiasm/recklessness.

The final chart revelation/interpretation is that Japanese stocks are over-bought. The Relative Strength Index (RSI) line above is reading over 70. As you can see, stocks can remain over-bought for longer than you think. But eventually, they almost always correct to the point at which they’re oversold (an RSI below 30).

We’re either headed higher in an inflationary melt-up driven by currency depreciation, or we’re over-bought already and on the verge of a hard fall. Line up. Take your bets. Winner takes all.

Regards,
Dan Denning
for Markets and Money

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From the Archives…

The RBA’s Interest Rate Bait Isn’t Attracting Many Bites
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A Prediction for 2013: Days of Abundant Natural Resources to Continue
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The Evolutionary Path of Boobus-Politicus
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The Unbalancing Act Happening in China’s Economy
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Marginal Utility: Steps Toward a Better Life
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