Will The Rally Continue?

Perpetual's Australian Equities Market snapshot – June 2009

The S&P/ASX 300 Accumulation Index rebounded 11.5%. This was the first quarterly rise since September 2007 and the largest quarterly rise since June 2001.
The S&P/ASX 300 Industrials Accumulation Index rebounded 11.6%. This was the first quarterly rise since September 2007 and the largest quarterly rise since December 2004.
The S&P/ASX Small Ordinaries Accumulation Index rebounded 26.7%. This was the first quarterly rise since June 2007 and the largest quarterly rise since the index started in 1992.

Throughout the quarter, most economic data signals demonstrated that domestic economic activity had considerable improved and markets rallied strongly as a result.

The Australian economy avoided technical recession in the March quarter posting growth of 0.4%. This was in response to strong growth in exports and a resilient consumer sector reinforced by large government handouts. Further support was added by a reduction in the RBA official interest rate to a 49 year low of 3%, with rates in the US, Europe and the UK also at record lows.

As the global economic picture has started to show some signs of improvement since early March, investors are now asking what the recovery will be like. It seems unlikely that growth in the developed economies will return to strong levels for quite a while, given the widespread deleveraging under way in the global household sector. This will have flow-on effects to the corporate sector where overall earnings and dividend growth would be expected to be more modest than a typical economic and earnings recovery.

As investor sentiment improved, commodity prices have rallied, bond yields rose and sharemarkets recovered. With sentiment supported by solid domestic economic data, sectors with cyclical earnings such as consumer discretionary (+18.0%), industrials (+15.0%) and energy (+12.6%) outperformed typically more defensive sectors like utilities (+0.5%), healthcare (+4.7%) and telecommunication services (+6.5%).

A significant feature of the last quarter has been Australian listed companies asking the equity market for capital in order to strengthen their balance sheets (paying off debt) and for additional company funding (due to the high cost of debt). Notable issuers over the quarter were ANZ, Macquarie Group, Asciano and Rio Tinto. Equity raisings have been happening for a while, and balance sheet risk is now evolving from one of corporate survival to one of funding future expansion. Despite balance sheets appearing stronger, the current risk for investors is that company earnings are still declining. With the recent rally in the market, some company valuations are currently appearing stretched.

We continue to select stocks cautiously, and pay particular attention to both earnings and valuations. Our focus remains on investing in companies with sound balance sheets, strong interest cover and sustainable business models.

We believe these quality companies will provide investors with solid downside protection should the market adjust from its recent strong rally and upside potential should the recovery continue.

source: http://images.perpetual.com.au/content/25997_Infocus_issue_3_Sep09/article5.htm