Last week while holidaying in New Zealand, I was reminded that investors don’t actually pay capital gains on their investments. However, the same cannot be said for Australia. In my opinion I believe we pay far too much tax on our investments especially when it comes to property where stamp duty and land taxes makes it almost impossible for an investor to turn a profit for several years.

In the share market people use capital gains tax as an excuse for poor portfolio management because they are concerned that if they sell they will have to pay too much tax. But let’s face it, if you are paying tax it means you have made money, which is the whole point of investing. Holding onto a stock simply because you want to avoid paying tax could cost you a lot of money and lost opportunity particularly if the share falls in value because you are losing profits. Indeed, the amount of capital gains tax you will pay could be much less than the amount you lose. A rule I always use, is to never make an investment decision solely based on tax.      

So what can we expect in the market?

In previous reports I have mentioned my concern that the market is currently travelling faster in price than we have seen in the last 25 years and it is doing so on lower volumes. Surprisingly, nothing has changed in the last week as the record pace of the current bull-run has continued to push the market to new all time highs. I do not believe this pace is sustainable and I still expect the market to fall by a few per cent over one or possibly two weeks in the very near future to bring some normality to our market. This is supported by the fact that over the next three weeks we are entering a very unpredictable time period on our market with natural support and resistance levels likely to be unreliable. Given this, I would urge investors to exercise caution over this period.  

To say that the rise in the Australian share market over the past seven weeks has been interesting would be an understatement. Since the low of 5490.80 points achieved on 16 August the market has risen around 22 per cent in 33 trading days. To put this in perspective, the final run up into the peak prior to the 1987 crash lasted 63 trading days, rising around 32.97 per cent.

If we compare these two periods, the current market has risen two thirds of the distance in price in around half the time. What is concerning is that I cannot find one period in the last 25 years in which the market has moved this fast in price. Right now many investors are behaving emotionally and investing in shares based on the fear of missing out, whilst most fund managers are sitting on high levels of cash. Given this, you have to ask who is making the right investment decisions.    
 
So what is happening on the market?

Currently, the market is showing signs of weakness given that it closed lower on both Wednesday and Thursday of this week, which could be the start of the pull back I indicated I was expecting in my last report. How long the market falls in time and price is critical in determining whether it will continue to be bullish in the medium term.

If the market is bullish, I expect it will only fall a few per cent in price over one or possibly two weeks. Right now I would encourage investors to be patient rather than to react emotionally given that investing in the share market is a medium to long term investment.

Based on the weighting of the top 20 shares in the Australian market, it would be fair to say that these stocks drive the All Ordinaries index. Given the bullish run the market has had since the low of 16 August, I think it is worth examining which of the top 20 shares has been driving the rise. 

As at the close of the market on 16 August up to yesterday (24 September 2007), the All Ordinaries Index has risen 14.63%. Of the top 20 shares, BHP has risen the most at 31.88%, closely followed by MBL and RIO at 30.94% and 30.13% respectively. Aside from MBL, which rose strongly given that it was oversold in the fall into 16 August, the other six banks in the top 20 only rose on average 8.84% with NAB only rising 4.85%. Only nine of the top 20 shares outperformed the All Ordinaries Index, while Telstra was the worst performing stock with growth of only 1.87%.

Given these figures it is fair to say that a large portion of the rise in the Australian market can be attributed to BHP, MBL and RIO. Outside of the top 20, the big movers were the resource stocks, therefore this is where the opportunities lie at present. While this is positive, what is concerning is that the banking sector is looking quite weak, which suggests that we may not have seen the end of the credit squeeze. 

So what can we expect in the market?

In previous reports I have suggested that for the market to prove it is bullish it needed to rise for more than 6 weeks and today brings to an end the six weeks since the low of 16 August.  Given this, if the current rise continues then probabilities suggest that the overall market is likely to be bullish for several months.

That said the market has behaved abnormally in recent times, therefore I have changed my opinion from being bearish to cautiously bullish. While the market will rise over the next month I believe it will fall for one to two weeks during that time. What happens during the fall will determine how the market unfolds over the next 6 months.    

This week the US Federal Reserve dropped interest rates by 0.5% in an attempt to under pin their share market given the current credit squeeze. Lower interest rates means two things: firstly, more cash in the market place leads to increased spending and secondly people tend to move their cash investments into the share market to receive dividends all of which is positive for the share market.

Obviously the government has achieved their goal as the US market has rallied this week, although I am questioning whether this is simply a bandaid fix to a much bigger problem. Prior to the 1987 crash, the use of leveraging skyrocketed, the US Dollar was falling as was the bond market, and things weren’t much different prior to the 1929 crash. While I don’t want to suggest that we will see a market crash, it is important to be aware there are many similarities between what is occurring now and what occurred then. So how does this affect us? Right now, many Australian fund managers are sitting on very high levels of cash even though the share market has been bullish over the past five weeks and you have to ask why?      
 
So what can we expect in the market?

Prior to the US announcing a cut in their interest rates earlier this week, our market had fallen away and was looking weak. However, it moved up strongly on Wednesday trading to its highest levels in nearly two months. Whilst this is a bullish sign, there are undertones in the current market conditions that keep me from getting too excited. That said there are shares doing exceptionally well right now such as BHP and RIO and there are many others that are presenting some great buying opportunities.

If the market is bullish, it will rise for another two weeks breaking above its previous all time high before falling away slightly. If it is bearish, it should turn down in the next week. Obviously only time will tell, therefore my advice to anyone intent on entering the market right now is to keep leveraging to safe levels.  

Last week I attended a public seminar run by the ASX where they introduced their new ASX CFD product to be launched next month. One of the reasons the ASX are launching this product is to capture some of revenues being generated by this the fastest growing area in the share market over the past few years. In talking with the presenters from the ASX I discovered that to date they had received a large response to people attending these seminars, but the alarming thing to me was that 70% of those attending had very little experience in the market and had never traded a CFD before.

Up until this new ASX offering the CFD arena has been delivered via over the counter product providers, whose offerings are normally limited to sophisticated investors, rather than mum and dad retail investors who are being attracted to this area like flies to honey. Some of the current CFD providers or their affiliates have used this attraction of retail investors by running dubious market campaigns, workshops and seminars akin to the snake oil salesman in order to attract new accounts. Given this I believe the new ASX CFD product will go at least some of the way to cleaning up this area in the share market and help protect the retail client, by giving them a more independent and transparent market, which obviously leads to lower risk. Regardless of the ASX participation anyone that is looking to trade CFDs needs to acquire knowledge and experience, otherwise they are taking high risk with their capital in this highly leveraged market.   
 

So what can we expect in the market?

In my last report I mentioned that if the market was going to fall it will most likely do so next week. Whilst as of writing this has been the case, the fall has not been very aggressive, in fact this week has really been one where the market has shown indecision and lack or direction. For more than a week we have seen generally lower volumes traded on the All Ordinaries Index, therefore the indecision in our market could be a positive sign that market sentiment is changing or it could just be the calm before the storm.

The market is constantly changing with new data arriving all the time, given this as an analyst it is important to be careful and not get a fixed view. Therefore if our market continues to hold its current levels or rises over the next week or so, then my opinion will start to change about further falls that I have been expecting. In saying this when it comes to the share market it is often better to have a pessimistic view than an overly bullish one, therefore it is still better to be conservative right now until we can confirm the direction of the market.