Bulls, 5005; Bears, no where to be seen

Well the S&PASX200 has finally punched through the 5,000 mark today. Whether that brings roundnumberitis euphoria or apprehension remains to be seen. I would point out, though, that the US markets got stuck at at either side of Dow 100 for about 20 years, including the Great Crash of '29, and again at Dow 1,000 for another 20 years including the Bear Market of '74-'75, and that it has been stuck either side of Dow 10,000 since the Tech Boom/Bust of 2,000.

To the delight of investors on the receiving end of stellar returns from equities, most market watchers are picking the bull market of the last three years to continue - albeit at a slower pace, and with more volatility. Since its beginnings in March 2003, the benchmark ASX 200 and the All Ordinaries have both gained about 80 per cent thanks to strong company profits and demand by China for raw materials. [Meanwhile, the US markets are still trying just to get back where they were six years ago.]

"For the market to hold these levels we are going to have to see continued strength in commodity prices," says CMC Markets senior dealer James Foulsham. "If we see a pullback in prices, its going to have an effect on the Aussie market."

While investors are no doubt wishing for a repeat of the double-digit returns of the past two years, market watchers are urging them to lower their expectations. Returns in 2006, they say, are more likely to be in the order of 8 to 10 per cent.

So what's the importance of the bourse passing 5000 points? To many brokers, it's just another day at the office. "Obviously it's a milestone but ... we don't get any extra pay in our pocket at the end of the week if it hits 5000," Gallagher says. "We're not going to hear the ching-ching of the register. It gives the broking community a chance to have a beer but apart from that it's business as usual."

During the past two months the bourse has shown signs of pushing through the landmark before retreating in haste. It has led market watchers to devise a term to describe the market's nervousness about the magic number: "Roundaphobia", or the fear of round numbers.

"Markets have trouble getting through round numbers," says Shane Oliver, the head of investment strategy at AMP Capital Investors. "Normally the market will respect it for a while and then eventually go through it, which it's likely to do in the next few days."

Despite trading at record highs, Oliver believes the fundamentals that have underpinned the sharemarket - including strong company profits, low interest rates and a strong global economy - remain sound. So sound, indeed, that Oliver reckons the market is still undervalued. A more fair value for the benchmark ASX 200 index, he says, is 5600 points.

Unlike in the lead-up to Black Tuesday in October 1987, share prices have lagged company profits. "The fundamentals are a lot more supportive this time around," Oliver says. "We are not in a situation like in '87 when the market became very stretched, [instead] we are running at the bottom of fair value."

In the 12 months before the '87 crash, the sharemarket surged about 90 per cent but profits grew only 25 per cent. In contrast, the market rose 17.6 per cent last year while profit growth was 23 per cent. Oliver believes investors can comfortably pencil in the bourse reaching 5200 points by the end of the year. [That's only another 4%, folks; you want to bank on that or maybe take some profits now?.]

"I don't see the Reserve Bank spoiling the party," he says, adding that interest rates are more than likely to remain on hold for at least the next six months. Furthermore, he believes the market is showing healthy signs of "broadening out" as investors show more interest in stocks other than resources, like those in the underperforming retail sector.

But as has been the case over the past three years, much still rests on the performance of the resource sector. After all, the resources boom driven by record Chinese demand has been a key factor behind the ASX 200's astonishing rise. Since the ASX 200 closed above 4000 points for the first time on December 20, 2004, the index's biggest stock, BHP Billiton, has risen 61 per cent. Shares in the miner's rivals, Rio Tinto and Woodside Petroleum, have made even bigger gains - up 83 per cent and 113 per cent respectively. The share price gains were on the back of record annual profits, and all three of Australia's biggest resources companies are expected to increase earnings even more this year.

Nevertheless, there are clear signs the growth rate is unsustainable. Goldman Sachs JBWere analyst Neil Goodwill predicts BHP will post a $US9.8 billion ($13.4 billion) annual profit in August before seeing earnings fall to $US9.2 billion in 2007. Rio is expected to follow a similar pattern.

Broker UBS notes that in 2005 earnings per share growth in the resources sector grew a whopping 73 per cent, but the rate is expected to fall to 44 per cent this year and to 11 per cent next year.

"We continue to see resources as an attractive sector, albeit not as compelling a proposition as in 2005," UBS strategist David Cassidy says.

Stalling commodity prices combined with rising costs have contributed to the growth rate slide. Nearly every mining company has seen project costs blow out due to equipment and labour shortages. After years of little growth, miners have been rapidly investing in new projects to exploit the high commodity prices. "You are going to see supply start to catch up," UBS resources analyst Glyn Lawcock predicted earlier this month.

Prices of some key commodities, such as nickel, [and tin and aluminium] have already fallen back from record highs. And although coking coal prices more than doubled last year, miners have settled for an 8 per cent price cut, starting April 1.

Other commodities are expected to make some price gains in the short term, but not at nearly the same rate as last year. While Japanese steelmakers agreed to a 71.5 per cent hike in iron ore prices last year, China is leading the negotiations this year and is taking a tougher stance. The market expects prices will ultimately rise by about 10 per cent this year but drop slightly next year.

Despite the slower growth rate, it isn't all bad news for investors. Even if commodity prices plateau, there's still money to be made through higher production levels that will come from companies with solid exploration programs.

UBS's Lawcock notes that Woodside and nickel miner Jubilee Mines look attractive in that respect. And although few commodity prices seem set to rocket in the near term, exceptions include zinc, uranium and alumina.

A global zinc shortage has benefited the world's second biggest zinc producer, Zinifex. [Son of a Guambat is riding this wave.] Uranium prices have continued to rise, providing gains for Paladin Resources. The company will soon begin production at its Langer Heinrich project in Namibia and already has sales contracts in place. And any increase in the alumina price will help Alumina, which owns 40 per cent of the world's biggest alumina business in a joint venture with Alcoa.

So while market watchers are ruling out the growth of last year, the sharemarket is still well placed to line the pockets of investors again in 2006. Nomura Australia market strategist Eric Betts says the fundamentals remain "reasonably good" for growth in equities over the next 12 months. "There will be times when we see retracing but we won't see a turning point in the short term," he says.

And as ABN Amro's Gallagher says: "At the end of the day it's a cyclical game. Bull markets don't last forever but it's not time to pull the bear suits on just yet."

Hold on to your hardhats.