What the economy needs

One analyst shares his views on what the economy needs.

Tim Radford, a global analyst for Rivkin, believes that for the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) to climb above the 5,000 point resistance level, overseas investors must once again see value in Australia’s high yielding plays. He believes this will only occur if the dollar begins to recover.

When the Reserve Bank of Australia decided to lower the official cash rate to 2.75% in May, the Australian dollar plunged. Whilst this came as much a much needed bout of relief for exporters such as our miners, it did not fare well for some of Australia’s highest yielding stocks – particularly the banks.

This is because, with the Australian dollar sitting at around US$1.03 (after having hit a high of US$1.06) at the beginning of May, Australian stocks were very attractive to foreign investors, where gains could be realised on both appreciation in stock value as well as in the currency exchange rate.

With high levels of turbulence throughout the global economy and record low interest rates around the world, foreign investors saw value in Australia’s defensive high-yielding companies. Through this trend, Commonwealth Bank (ASX: CBA) overtook mining heavyweight BHP Billiton (ASX: BHP) to become Australia’s largest company by market capitalisation. Meanwhile, between the market’s lows in June 2012 and May this year, ANZ (ASX: ANZ) and NAB (ASX: NAB) both saw 57% gains whilst Westpac (ASX: WBC) appreciated 74% – the highest of any of the banks.

However, as the dollar depreciated, foreign investors ran for the door, causing each of the banks to depreciate in value significantly. Radford believes that the Australian economy will rely on the banks to continue their recovery in order for the index to remain above 5,000 points. For that to happen, confidence must be restored in regards to the strength of the dollar to make these high-yielding plays more desirable once again. If not, he suggests that the index could instead head back towards its June levels of around 4,700 points.

Foolish takeaway

Whilst the banks make up an enormous portion of the ASX 200, the economy largely relies upon their strength to be driven forward. However, for investors focused on the long-term, the banks are unlikely to outperform the market at their current prices. As such, it may be worth looking elsewhere to put your hard-earned money to work.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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