The Australian share market has piled on more gains over the past 35 days than it did during the whole of the previous year.
So far this year, the S&P/ASX 200 index is up 6.7%.
It’s amazing what a little interest rate cut can do for the market.
The Aussie market closed yesterday at 5,777 points.
That’s still a long way from the target we set 18 months ago of it reaching 7,000 points by the start of this month.
But is it possible that even though we got the timing wrong, the target number could still be in sight?
In fact, far from being despondent about the market falling short of our target, the events of this week give us even more reason to believe that it’s only a matter of time before the index hits our 7,000-point goal…
The past week should give investors cause for hope…and concern.
The hope is that the Reserve Bank of Australia’s (RBA) interest rate cut has shown everyone that Australia isn’t so different after all.
Australia doesn’t have a miracle economy.
The end of the last resources boom has revealed that the Aussie economy really was a one-trick pony.
Now the economy has to adapt. China may still have an insatiable appetite for resources, and this will grow even more. It’s just that China won’t pay the sky-high prices it paid in the past.
That means the Reserve Bank of Australia has to do what every other central bank in the Western world has had to do — crunch interest rates lower than ever before.
And the latest cut won’t be the last.
What low interest rates can do for stocks
All the talk is about the RBA being reluctant to cut interest rates. They say the RBA is worried about fuelling a new house price bubble.
That may be true.
But something else worries the RBA even more — a house price crash.
Hence, the RBA cut rates.
The impact on the Aussie stock market was instant. You can see that in the chart below:
Now, stocks had already rallied before the interest rate cut. The Aussie market had been on a strong run since the middle of January.
So this was just the icing on the cake for stocks.
The issue now is how much farther the Aussie market has to run. One key point out of this is that the Aussie market is now at its highest level since May 2008.
That was the period of extreme volatility before stocks really began to crash. But importantly, it means the market is within touching distance of the 2007 high.
All of this should embolden investors to take the plunge into stocks. It’s why, despite the volatility over the past few years (yes, there has been a lot of it), we’ve continued to recommend investors invest in stocks. We still do. This rally is only just getting started.
We’ve known all along that the time would come when the RBA would have to follow the lead from overseas. The only thing we didn’t know is when it would happen.
Well, it’s happening now, and the current market has all the hallmarks of the 2012 dividend yield rally.
Has the inflationary boom just begun?
We mentioned earlier that this rally should offer hope and concern.
You really must be aware of that. This stock rally is great. For the past three years, we’ve said you should buy into it…and we still hold that view.
But don’t for a minute confuse rising stock prices with an improving economy. One doesn’t necessarily mean the other. The single biggest reason why stock prices are rising around the world is the combination of low interest rates and money printing.
Don’t forget that.
What you’re seeing now is simply a result of inflation…as more money sloshes around the system. The thing is, a whole bunch of that money is still on the balance sheets of the world’s banks.
They’ve been too scared to lend it out for fear of a repeat of the 2008 market crash.
But at some point, that ‘hoarding’ mentality by the banks will change. They’ll start to believe that a real recovery is taking place. That’s when they’ll start to loosen up and push money into the system.
When then do that, boy, if you think this stock rally is something, be prepared for what’s coming next. This is how all inflationary booms begin, and the resulting crash is how all inflationary busts end.
Again, just as we didn’t know for sure when the Aussie market’s inflationary boom would begin, we don’t know for sure when it will end either.
But there is one thing about which we’re 100% sure: the Aussie stock market has been in the doldrums relative to other markets in recent years. Now that the RBA has joined in with super-low interest rates, it won’t take long for Aussie stocks to catch up…and it won’t take long for it to hit our 7,000 point target.
We got the timing wrong, but better late than never.
Editor, Tactical Wealth
Editor’s Note: This article was originally published in yesterday’s Money Morning.