The ASX 200 Could Rebound 15% by 2016, But There’s a Catch

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Deutsche Bank is bullish on the future of the Aussie stock market. The investment bank believes the ASX 200 is on course to rise 10% over the next year. But it comes with a word of caution for investors. Such an optimistic outlook on growth hinges on Australia avoiding a recession.

That’s a big if. Company profits and earnings are flat, and investment is down across the board. It’s expected that GDP figures for the second quarter will show negative growth. Avoiding a recession is no foregone conclusion. But before we look at this more closely, let’s see what Deutsche Bank projects for the ASX.

The German bank listed off a bevy of stocks that could gain ground over the next year. As expected, the big four banks lead the way. Deustche believes the major banks remain cheap, offering good value for investors. In addition to banks, Deustche Bank rated healthcare stocks as ones that stand to gain as well.

Harvey Norman [ASX:HVN], Stockland [ASX:SGP], AMP [ASX:AMP] were among other picks.

Meanwhile, the bank was bearish on the resource sector. It maintains the sector is still overvalued.

History of ASX the key to recovery

How accurate is Deutsche Bank’s outlook on the future of the ASX 200?

Only last week, the ASX shed $70 billion worth of value. That represented a 4% decline in the total market cap. What’s more, a snapshot of the last six months reveals losses of 15% on the ASX.

Yet, according to Deustche Bank, we’ve seen all this before. Since 1960, the ASX has declined by similar amounts on 13 previous occasions. In the aftermath of such dramatic drops, things usually went in one of two directions.

The first is that the stock market rebounded by 20% or more over a 6–12 month period. But there were also occasions that it underwent another 20% decline.

In other words, things could improve, but they could also worsen. Not much of a sample to go on, is it? Well, here’s where things get interesting.

Deutsche Bank notes that the ASX typically rallies 15% in the event the economy avoids a recession. Here’s the bank’s take on this:

‘[Our view is] that a recession is not imminent. We expect the market to rise in a similar fashion to historical precedents. Indeed, the market is already up 5% since last Monday’s trough’.

Despite this, it hasn’t stopped it revising its projections for the ASX 200. The bank now forecasts the ASX 200 to hit 5,600 points by the end of this year. That’s down from a previous estimate of 6,2000. At the same time, by June 2016 it projects the ASX 200 could reach 5,800, down from 6,350 points. And, by the end of 2016, the index could reach 6,000 points, according to the bank.

The ASX looking ahead to 2017

Like Deutsche Bank, investment bank UBS is also revising its outlook for the ASX. Here’s its assessment:

Valuation does not appear overly compelling in absolute terms. But we believe relative values versus low interest rates is the key positive support.

A subdued outlook for the domestic economy [means] market prospects [beyond a short term recovery are] constrained by mediocre earnings growth.

We believe the positive earnings impact from further falls in the Australian dollar…remains the key potential positive in the earnings cycle’.

That assessment is in line with the kind of earnings growth we’re seeing. Almost three quarters of Australia’s 200 biggest companies are seeing earnings fall. Combined profits of 143 companies saw earnings plummet by a third from a year earlier.

But these companies still have relatively healthy balance sheets. That’s why they’re rewarding investors with progressive dividends. However, this comes at the expense of investment in new projects. As a result, it’s hard to see then how corporate Australia will break this chain of falling earnings.

And that puts Australia’s entire economy at risk of decline.

Why the 15% ASX recovery might be overblown

Company profits fell 1.9% in the June quarter. In fact, profits declined for the fifth consecutive quarter.

The GDP figures for the second quarter are due this Thursday. We’ll get a better picture once these numbers are released. But early signs point to declining growth.

The economy grew at 0.9% in the first quarter. Yet analysts now predict the economy may have grown only 0.4% in the second quarter.

As you may or may not know, a recession is two straight quarters of negative growth. If company earnings, and profits, are down, what does that say about the future? No one expects a pick up in investments during the third quarter between July and September. Nor is there any expected rebound in commodity prices to boost growth.

All this raises the likelihood of growth falling yet again in the third quarter. That makes a recession not only possible, but increasingly likely.

This comes as no surprise to The Daily Reckoning’s Greg Canavan. He’s maintained all year that Australia is on course for its first recession in 23 years. In the event, it makes any 15% ASX recovery a distant dream.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why our economy finds itself in the hole it’s in. He’ll show how debt levels have spiralled out of control. And he’ll prove why that means a recession is almost inevitable.

But there are actions you can take right now to lessen the blows of the recession.

Download your free copy today to learn how to protect your wealth from the fallout of the crash. To find out how to download his free report right now, click here.

Mat Spasic,

Contributor, The Daily Reckoning

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