After five years of quantitative easing in the US and after $US4.5 trillion of liquidity entered the market, the aggressive “pump priming” from America is over.
What does this mean for an investor?
The first thought that comes to my mind is concern. The extra liquidity that has been pumped into the system has been forcing up asset prices across the globe, particularly in the stock market. Since the US market bottomed on 6 March 2009 at 666, the S&P 500 Index is up over 200%. However it hasn’t been smooth sailing.
In June 2010, after the first round of quantitative easing (QE1) finished, the S&P 500 Index fell 15%, fearing a further slowdown in the economy and a decline in asset prices. Then, the US Federal Reserve commenced QE2, which led to further rapid increases in the equity market. However, when this stimulus was removed again the market started to wobble, falling 20%. It remains to be seen how the market will react following the end of QE3 and whether the recent falls from mid-September to mid-October are a sign of things to come. This time, however, the US economy is undoubtedly in a better position and global liquidity is continuing to be pumped into the system by similar quantitative easing mechanisms from Japan and Europe.
What should I do?
Given the high valuations that have resulted from the excessive global liquidity, it is prudent that investors hold higher than average cash levels to take advantage of opportunities when they arise. The Australian equity market is not cheap, having risen over 50% in the last three years, and is trading above historical valuations. We know from experience that there are always opportunities in the market. The Australian dollar should continue to weaken against the US dollar, as the end of the QE program in the US removes a source of upward pressure on the Aussie dollar. I expect it to fall towards $0.75. Therefore, with a stronger US economy and a weakened Aussie dollar the best stocks to buy are those with significant US dollar earnings.
What to buy?
There is always a wide magnitude of factors affecting the earnings and valuation of a company, so a stock should not be bought purely on the back of one factor alone. The stocks below all benefit from a falling Aussie dollar and an improving US economy, but, as always, investors should conduct their own research before purchasing shares in any of the following companies.
Aristocrat Leisure (ASX: ALL) is a developer, manufacturer and distributor of gaming machines, primarily pokie machines. Seventy seven per cent of Aristocrat Leisure’s revenue comes from outside Australia and a 10-cent fall in the Aussie dollar would result in an increase in EPS of 14%. The company has performed strongly already this calendar year and is up 41%. Aristocrat is currently trading on a P/E of 21x with EPS growth of 51%.