What are the prospects for the Aussie Stockmarket after the Rate Cut?

After a blistering couple of weeks in the Australian stock market, which included a base rate cut by the Reserve Bank of Australia, we’re starting to see headlines such as “Australian stocks surge to new seven-year high on rate cut optimism“.  But is the rate cut really what’s driving this market higher? And what are the short term prospects following such a run of consecutive up days?  To get to the bottom of it, I decided to run some tests.

On the first question of the rate cut, this was the 15th rate cut in recent times.  If you look back over the previous 14, you can can find some picture perfect examples of where the indices had a great run following a rate cut, such as in December 2012:

All Ords Index following December 2012 RBA Rate Cut

But if we line all the rate cuts up and look at the percentage gain in the ASX200 Index ($XJO) in the 17 days following the announcement, the picture becomes more mixed.

From this chart, there doesn’t appear to be any correlation between an RBA rate cut, and what happens in the stockmarket in the weeks following it.  At best it’s a coin toss which way the market goes following the annoucement.

So, what about the prospects for the market following such a long run of consecutive up days?  As I write, the All Ords has experienced 11 higher daily closes in a row.  Many investors think this shows the market is overbought and the short term prospects are negative.  But what do the statistics say?

As there haven’t been many instances of the market being up 11 days in a row (only 2 plus the current one since 1992), I decided to look at runs of 10 consecutive up days, using the All Ords ($XAO).

As you will see below, although the sample is not huge, there has been a positive edge to the market following such runs in the past.  5, 10, 15 & 20 days after a run of 10 up days are all positive on average, with a half or better of each case returning positive outcomes.

The thing that really stands out from this study though, is that almost all the examples come from times when we were in the early stages of a bull run.  In other words, it’s the early stages of a bull market that seem to have all the necessary ingredients to be able to produce such an unbroken run of higher closes.  And so it is this perhaps, more than anything, that offers the best clue to the current state of the market, and the prospects for the short to medium term.