The Chicken or the Egg Conundrum

Like the chicken-or-the-egg conundrum, it is always an interesting question as to whether increased confidence in the stock market causes it to rise, or whether a rising market makes investors more confident.

Australian shares have not been the place to be over the past five years, actually losing money for investors. But in June 2012, the share market's S&P/All Ordinaries Index began to move, and has gained 26 per cent since then, surging through the psychologically important 5,000-point level on both the S&P/All Ordinaries Index and the S&P/ASX 200.

At the same time, the market's forward (prospective) price/earnings (P/E) ratio bounced sharply off ten times earnings, and has risen to about 15.5 times earnings.

The rise has sparked investor interest. Or did a pick-up in investor interest drive the rise?

Certainly, indicators of bullish sentiment are flashing ‘green,' here and overseas, as money pours back into the market, in what European Central Bank (ECB) President Mario Draghi calls “positive contagion.” The massive amount of central bank liquidity support thrown at the markets, plus the new-year political deal in the United States to avoid the so-called fiscal cliff and improving economic conditions in China, have helped to push stock markets higher. Simultaneously, difficulty in extracting any return from over-bought bonds and minuscule interest rates, have driven investors into the so-called “great rotation” out of bonds, and back into shares.

Here in Australia, the Reserve Bank of Australia has cut the official interest rate to 3 per cent, holding just above a record low. Investors are starting to respond to the lightening of interest-rate pressure, with the Westpac/Melbourne Institute Index of Consumer Sentiment rising by 7.7 per cent in February, from 100.6 in January to 108.3 in February, the biggest monthly gain since September 2011 and the strongest reading on the index since December 2010.

The increased confidence is definitely being felt on the stock market.

Indices:

The Australian All Ordinaries Index has moved up increasing +37 points (or +0.7%) since closing last Friday to 03:10 pm today.

The rest of the world as measured by the MSCI index increased 3 points (or +0.9%) in A$ from closing last Friday to end of trade Thursday.