Australian shares set to gain once hurdles cleared

The market has fallen over 5 percent so far this year, underperforming most major markets, forcing strategists to slice forecasts, but they expect the market to gain steam in the second half because stocks are cheap.

"The risks over the next month or so are quite considerable. They are a lot higher than they have been for quite some time," said Damien Klassen, an analyst at Wilson HTM Asset Management.

" We are still pretty heavily overweight cash and we are happy to wait out this period of volatility."

The benchmark S&P/ASX 200 index , which fell 2.6 percent last year, is forecast to rise to 5,100 by year-end, a 13 percent gain on Thursday's close of 4,500 but 5 percent lower than forecast three months ago.

Estimates in the poll of 15 analysts, taken over the past week, ranged between 4,918 and 5,500.

The factors holding back the bulls include Greek debt, the withdrawal of the US Federal Reserve's stimulus, slower US economic growth, and inflationary fears in China.

The external concerns, combined with freak weather which hit growth in Australia in the first quarter, have weighed on share prices in the first half, pushing some shares down to their weakest levels since the global financial crisis hit.

"While the flood of US dollars that has buoyed asset prices will be withdrawn eventually, recent data confirms that the key international drivers of Australian share prices -- Chinese demand and US recovery -- are likely to support higher share prices in the medium term," said Michael McCarthy, chief market strategist at CMC Markets.

The market has also been held back by the strength of the Australian dollar, which has deterred foreign investors from putting new money into the market and triggered profit-taking by foreign investors cashing in on their Aussie dollar gains.

Domestically, cyclical stocks, like retailers and media, have been weighed down by expectations that the Reserve Bank of Australia will raise rates, as it expects the mining boom to boost inflation.

At current share prices, most stocks already reflect worst case expectations for profit growth, and strategists believe that if the external clouds lift, company results in August should be a catalyst for a market turnaround.

"We still do expect downgrades. But we think it's still possible to get to 5,200 even with continued downgrading, as long as the downgrades aren't too severe," said UBS equities strategist Dean Dusanic.

For the market to rebound strongly, the banking sector, the market's biggest, would need to fire up. Bank shares have been sliding on worries about weak credit growth and perceptions offshore that Australia is vulnerable to a housing bubble.

If Australia's central bank holds off on rate hikes, that should ease pressure on the retailers and the banks and underpin a market turnaround.

Copyright Reuters, 2011