Market Condition - Medium Term Outlook

This page is in two sections:
A. 28 April 2010 status of indicators of Medium Term Outlook
B. General discussion of assessing Medium Term Outlook.

A. 28 April 2010 status of indicators of Medium Term Outlook

Best guess estimate of appropriate weighting in stocks for a retired person concerned about avoiding massive losses is say 70 to 80% with no gearing. About 50% of stocks should be in other than Australian stocks in view of strength of AUD and to take advantage of relative strength of Emerging Markets and Commodities
Bonds to 3 years for 20 to 30%.
State of watchfulness should be weekly monitoring.
Outlook remains of concern in view of sovereign debt in the EUR countries which don't issue their own currency, consumer debt to GDP in many developed countries, external debt to GDP in many developed countries, un and under employment in the US and some other developed countries, housing oversupply and shadow inventory in the US, proportion of mortgagors underwater or nearly underwater and therefore no borrowing capacity in the US.

Yield curve:
(ratio of 3 month rate to 10 year rate)
(consider buy less than 0.5, hold 0.5 to 0.8, consider sell 0.8 and above)
US: Buy (0.15/3.82 = 0.039)
Australia: Buy

Price to 200 day SMA:
(price as a percentage of 200 SMA)
(consider buy when 200 SMA crosses from below Price to above Price and holds for 10 days, hold while above, consider sell when 200 SMA crosses from above price to below and holds for 10 days)
US Dow: Hold (200 SMA above Dow index value by about 10%)
Australia: Hold (200 SMA above All Ords index value by about 5.3%)

Level and trend of ratio of Earnings to 10 years Average Real Earnings
(consider buy when turns up from below 1.0, hold while rising to 1.25, consider sell above 1.25)
US: Hold, rising trend at 1.2, but earnings forecasts are positive for future periods.
Australia: ??

Level and trend of ratio of PE10 to PE of 10 year bonds
(Consider buy when turns up, particularly from below 1.0, consider hold while increasing, consider sell when turns down, particularly from above 1.2)
US: Hold, increasing at 0.84
Australia: ??

Length of Bull Market
The current bull market has been running for 13 months. That puts it in the 40 to 45% of the 20 bull market lengths since 1900.

Size of Rise this Bull Market
The current bull market has enjoyed an 80% rise (albeit after a collapse of over 53% (US)) which puts it in the 60% of all the bull market rises since 1900.

Watch for start of a fall in AUD which is near historical highs in EUR, GBP, USD, CHF. Consider up to 50% of exposure in currencies other than AUD.

Long term trend has been declining long and short interest rates, short term trend is flat but with likely increasing short interest rates within 6 months. Long rates can continue to decline if consumers continue de-leveraging, but common prediction is rising rates.
US: (Cash rates are effectively zero and no tightening likely soon given unemployment). Bonds to get yield but keep duration to less than 3 years.
Australia: Short interest rates already rising. Bank term deposits, bank bills or AAA/P1 corporate paper, all to 1 year only.

Other major stock markets
All have P > 50 > 100 > 200 other than China, Hong Kong, Spain, Italy and so are Hold on that indicator in their local currency.

Some markets have risen more dramatically than most:
(Market, Rise from Low, Percentage of peak recovered)
Singapore 105% 77%
India 117% 85%
Mexico 100% 103%
Brazil 136% 95%
Indonesia 163% 103%
Turkey 175% 100%
Argentina 195% 104%

B. General discussion of assessing Medium Term Outlook.

The medium term outlook for the market depends on, or is shown by such things as:

1. current, and outlook for, fiscal and monetary settings
2. inflation and expectations
3. interest rates and shape of yield curve
4. preference for shares over bonds
5. momentum of market
6. PE ratio compared to inverse of Bond Yields
7. company profits and forecast profits
8. dividends and expected dividends
9. length of current stage of market: time since last downturn/peak/trough
10. likelihood of additional consumer and business demand which in turn depends on borrowing capacity, inventories, un and under employment, temporary tax credits and other incentives
11. likelihood of additional government demand which in turn depends on the political impacts of additional borrowing to fund additional demand, current deficit levels, current inflation levels, level of foreign indebtedness.
12. ability to issue and debase the currency - particularly relevant to European Monetary Union countries eg Greece
13. exchange rate trends which affect the "competitiveness" of imports and exports and hence manufacturing volumes and employment and the comparative value of assets and liabilities.

Our focus though is on maximizing total return of our investing in our domestic currency, not so much on economic conditions per se, although changes in sales, inventories, production and transport (including bulk shipping) volumes are relevant information.

The main decisions are:

1. At what level will we focus, domestic market only, developed markets, emerging markets, market sectors (again in which markets) or individual companies?
2. Will we use gearing at any time?
3. Are we buy and hold or market timing oriented?
4. Will we use options and if so in what ways:
a) to increase yield by selling well out of the money options
b) to increase rewards of stock appreciation by buying calls
c) to hedge downside by buying puts
d) to profit from falling markets by selling call options and buying put options
5. Will we use currency forwards to:
a) hedge all currency exposure back to AUD
b) achieve some desired balance of exposure to various major currencies
c) rebalance exposures based on perceived risks of AUD falling relative to specific other currencies (eg USD in times of "flight to quality"