The surge in the performance of risky investments, including Australian shares, over recent weeks, can be traced directly to a sharp bounce in investor confidence.
This has been in response to announcements by the European Central Bank of potentially unlimited government bond-buying plan and the US Federal Reserve’s of further monetary stimulus via another round of quantitative easing (QE).
To cap that off, the Reserve Bank of Australia’s cut in interest rates in early October ensured that the local market didn’t miss out on the action.
All guns blazing
This adds up to an impressive amount of central bank firepower aimed at a global economy stuck in the doldrums. In response, both the Australian and US share markets have risen 14 per cent from their trough in early June, while the European index has jumped 17 per cent.
To put this rally in perspective, the announcement of QE2 in late 2010 helped the US and Australian share markets to a 16-per-cent rally through the second half of that year, while the first round of quantitative easing in early 2009 sparked a dramatic rally of more than 50 per cent over the balance of that year.
Admittedly, this occurred against a backdrop of exceptionally distressed markets at the height of the global financial crisis.
Already priced in?
These observations suggest that the market impact of emergency monetary measures such as quantitative easing is becoming progressively less pronounced as investors become more conditioned to them. If so, then it may be that most of the announcement effect of the latest measures may already be priced in to the market.
We could see a more extended rally in share markets, but that will be determined by the success of these monetary measures in boosting underlying global and domestic economies and hence corporate earnings.
Indeed the evidence from the US is modestly encouraging. There are signs the housing sector, the epicentre of the global financial crisis, is gradually healing and is at the early stages of what could be a reasonable upswing. Whether this nascent recovery can withstand the impact of the looming fiscal cliff the US has to negotiate in 2013 is the major uncertainty.
Extend or sustain?
The prognosis is not so comforting elsewhere. While the European Central Bank’s stated intentions have calmed market fears about the outlook for the eurozone, the crisis there remains alive and well in the form of decaying economic activity, rising unemployment, banking insolvency and escalating social stress, all amplified by misguided austerity measures.
Chinese official data should also be taken with a pinch of salt. The most recent GDP data, suggesting a moderate slowdown in growth to 7.4 per cent over the past year, likely understates the true extent of the cooling off taking place.
Against this still very difficult global backdrop, the challenge for share markets, including the local one, may be less about whether the rally can extend and broaden, and more about simply sustaining the gains seen to date.
Michael Karagianis is an Investment Strategist at MLC Investment Management.
