Rudi On Thursday

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

This story was originally published on Wednesday, 15 April 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere.

By Rudi Filapek-Vandyck

Last week, FNArena colleague Greg Peel pointed out to me banking shares had hardly achieved any further gains since the three week-rally in March. At the time I found this quite revealing as my impression from reading newspapers and other media, and listening to commentators on financial television, was that equities had continued their rally for five weeks in a row, and banks were in the drivers’ seat of the global rally.

Today -in the middle of week six of the rally- I had another look at Commonwealth Bank ((CBA)) shares, only to find out CBA shares are trading only marginally higher than in the fourth week of March.

I immediately looked up what has happened to the S&P/ASX200 index. Only then I realised I had been bamboozled by positive reports in the media. Australian shares have hardly moved in April – on a net basis. In fact, it would only take one day of benign losses to pull the index back below its closing level of April 3. So what’s all this five-six weeks in a row of gains?

If we’d go back through the past six weeks we’d notice how US shares managed to close higher each Friday compared to the previous week, but only just so on Friday last week. In Australia we actually closed at a net weekly loss last Thursday (with the index ending week five marginally below the close on March 27), but we made up for it by starting week six on a strong note. This, however, was offset by the fact the Dow Jones Industrial Average (DJIA) is already below its closing level from April 3. One more day of moderate selling could take the Dow back to its close on Friday March 27.

So much for the widely touted road to a sustainable recovery. If anything, I think we’ve all been misled by positive media reporting. Equity markets have not been rising uninterrupted for six-and-a-half weeks They rallied for three weeks back-to-back, very strongly, and after that they started treading water, making virtually no further gains.

This now offers us with an interesting dilemma: is this pause positive or negative?

Let’s tackle the issue by first addressing why equity markets started rising in the first place.

“Behavioral psychologists will point out that financial market euphoria or confidence is very dependent on the fact that price momentum becomes a self-fulfilling prophecy. Paradoxically in finance, as prices go up, people buy more. By central banks buying long-term securities, they are trying to avert a 1930s deflationary depression whereby declining prices and falling sales forced huge numbers of banks and businesses into bankruptcy. Just as people can adjust their spending behaviour based on recent price moves for staple or durable goods in the real economy, so too can investors adjust their risk appetite based on recent movement in financial asset prices”

The above quote is taken from a recent report by Nomura International. I think it captures perfectly what governments and central bankers around the globe have achieved since early March: share prices have stopped falling. Even more so, helped by frantic short covering, authorities have achieved that share prices across the globe have started rising again. By doing so they have -at least for the time being- radically changed the mood and psyche of today’s investors. Nothing is more attractive than seeing share prices rise. Nothing.

To put the overall change since early March in concrete terms: whereas investors were previously worried about possibly taking on too much risk and potentially suffering even more losses, they have now become itchy and nervous they might miss out on what could potentially turn out the transformation rally into the next bull market. In both scenarios we’re talking investors with sweaty handpalms, but for very different reasons.

The key psychological impact from this major change should not be underestimated: whereas continuously falling equity prices gradually erode confidence of even the most optimistic market bulls, six weeks of rallying share prices (or so the media wants us to believe) does the exact opposite: it establishes a positive framework and the longer it lasts the better the odds it will establish a positive self-fulfilling process.

Stockbrokers, and not just those in Australia, are reporting a remarkable pick-up in overall interest for the share market among their clientele. Apart from the general media, it is my personal observation that tipsheets, financial services and media are increasingly stepping into the limelight while promoting positive money making opportunities.

One could argue the positive self-fulfilling process has already started. If I was fooled into thinking shares had rallied for six-and-a-half weeks, what do you think is the perception by others who spend far less time observing and analysing financial markets?

Did you realise share markets have hardly moved in April?

In my editorial on March 25 I predicted this rally would end in the vicinity of 3780 (ASX200). Today, that almost seems like a hundred years ago. But here we are, three weeks later, and the index still hasn’t been able to surge beyond that level. Taking a leaf from the book of experience written by far more experienced investors, I can only conclude: there’s no such thing as a triple top. The share market in Australia has now tried two times in a matter of weeks to attack its highest close so far this year, and it has failed on each occasion.

I think the rally is getting tired. Unless 3780 will be broken soon, it is time for a pullback.

However, and this question will prove to be the key for the market’s outlook for the medium term: is present investor optimism strong enough to deal with the headwinds created by ongoing negative economic and corporate data?

The answer will be provided by how orderly, and how deep/shallow the next pullback will prove to be.

Thus far the signs -there for all to see- have been very encouraging, if not surprising. Qantas ((QAN)) issued a profit warning this week and even though the initial market response was exactly what one would expect -heavy selling and a double digit price decline- the end result has been for a stable share price and only one broker recommendation downgrade.

Similarly, the current rally in resources, and in resources stocks, has taken place against the background of a continuously falling Baltic Freight Index. Remember, when this index seemingly started to turn around in February commodity investors got all excited again. The irony is that the index peaked just before equity markets started rallying in March and the index has again lost more than a third since. But commodity prices have surged further regardless and BHP Billiton ((BHP)) shares are back above $33.

However, key for the immediate outlook for share markets is not whether economic data and corporate results will be bad or not (they are and they will be) – it is whether investor confidence has grown strong enough to look through the clouds and still see the glass as half full. Imagine if the answer turns out “yes it is” and many who are still short resources and bank stocks (outside Australia) are forced to start buying?

(Longer term we will still face the issue of whether fundamentals will eventually pick-up on potential investor optimism, but that’s a matter we might choose to deal with at another time.)

With these thoughts I leave you all this week,

Till next week,

Your editor,

Rudi Filapek-Vandyck

(As always firmly supported by Greg, Andrew, Joyce, Grahame, Pat, George and Chris)

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