FYI | Mar 22 2010
FNArena editor Rudi Filapek-Vandyck shares his insights and analyses on a regular basis with paying subscribers via stories labeled 'Rudi's View'. On occasion, one of these stories is shared with non-paying members and with readers elsewhere. This is one such occasion. The story below was originally written and published on Wednesday, 17 March, 2010.
By Rudi Filapek-Vandyck, Editor FNArena
But Rudi, one FNArena subscriber asked me this week, your view is often opposite the majority view in the market, and you never consider this as a reason to change. Why should we follow the majority now that the short term view has turned positive? Doesn't this merely indicate that a correction is coming?
For those who may have missed it: the question above was in response to a story I wrote earlier this week, wherein I reported that according to my personal observations a majority of market commentators and experts had turned positive on the immediate outlook for risk assets, including Australian equities.
For more details see: “Rudi's View: No Shortage Of Positive Views”, 15 March, 2010.
There's a difference between my observation over the past few weeks and the times I stood firm in my opposite views (November-December last year on gold, August 2008 on resources and the second quarter of that same year on crude oil – to name but a few). That difference is the size of the market majority.
I do not have any reliable measurement to gauge what exactly is the current balance between bears, bulls and those who remain undecided in today's market, but I do know for certain there's not one clear “winner” at the moment. To the contrary, what I think is happening is that equity markets are climbing the proverbial wall of worry.
Not a day goes by or at least one email in my inbox predicts a return to the Doom and Gloom days that prevailed prior to March last year. And that's not to mention all those technical analysts who count waves and mini-waves and have no doubt that markets remain on cue to revisit the March-2009 lows, and then head lower.
In the absence of a clear market consensus, and without any sudden shocks to the global financial system, share markets have been grinding higher over the past month. Most bearish commentators have stuck to their guns, arguing it cannot be real what's happening because it's all on low volumes and on deceiving headlines only (and those are just two key arguments).
I do remember clearly from last year that the rally in March equally started for all the wrong reasons, and at times volumes were pathetic. Yet, here we are today, more than 50% higher, and climbing higher day after day (sort of).
The lesson I learned from last year's rally is that it doesn't necessarily matter how things start off, it's what comes next that matters. Many of the bearish commentators today have been forced to apologise to their readers for missing all the action last year.
I didn't have to. Since June last year I have been suggesting to everyone who cared to listen to concentrate on FY11 forecasts – and I am still doing so today. I still think it is the right thing to do.
But what's really important in this matter is that by late February last year it was virtually impossible to find anyone around who was blatantly (and genuinely) bullish and prepared to make his voice heard loudly. This is why the initial up-days were met with so much criticism and disbelief, and why trading volumes were so pathetically low at times.
It's because no-one believed it would last that it did.
To put it in another manner: the majority view at the time was outspoken negative, but also, the majority was not simply outnumbering the others, the size of the majority in the market was overwhelming.
As is often the case, when the market is so far out of balance in one direction, then the market will correct in the opposite direction to restore a better balance. This is, in a nutshell, what happened in the gold market in December last year, across all base materials in September 2008 and in the oil market from the second quarter of that year.
I could also mention sugar this year January, and uranium in mid-2007, or the US dollar prior to November last year. There are plenty of examples to pick just from the past few years. I am sure you see a picture emerging by now.
Bob Farrell's rule number nine: When all the experts and forecasts agree- something else is going to happen (see Take Note on the FNArena website).
A few weeks ago I heard one expert arguing on financial television that the reason why global share markets only corrected by 8-9% between early-January and mid-February is because everyone seemed convinced a correction was coming, and it would be in the order of 20-25%.
I instantly realised this was probably correct. I too was expecting to see more downside. While not everyone had been warning for a pull back in advance, like I did, I do think that by the time equities were down more than 5% a general view had crept into the market that a larger correction was in the making.
Despite selling orders coming in with force, causing most technical indicators to turn ugly and support levels giving in rather easily, it still didn't happen did it?
This is what democracies and financial markets have in common. From the moment you see some politician receiving 90% of all the votes, you instantly realise the country is not a democracy but a dictatorship. Unfortunately, investors don't vote before they make an investment decision, so we have to use other ways for measuring market sentiment. But once you believe it is reaching the point where the market starts resembling a dictatorship, it's time to withdraw to the sidelines and watch the spectacle unfold.
This, however, is not what is happening in the markets right now.
If there is a majority right now, and I believe there is one, it is a rather small one. But whatever there is as a majority, it is growing. This is positive for risk assets as it creates a positive loop: increased investor optimism leads to rising prices, this leads to increased optimism, which leads to rising prices.
If you're a cynic, like me, you'd say: but doesn't this loop start with rising share prices instead of increased optimism? I believe it does. But once the process is set in motion, it's all about what comes next. Similar to March last year.
If you're a sceptic, you would say: if it's only about investors acting upon their optimism, this can possibly not last very long. After all, isn't that in essence what was happening in all the examples mentioned above – until it all came unstuck?
You'd be correct.
But that's not all there is to it today. Economic data have provided support to increased optimism (look, for example, at today's release of Leading Indicators in Australia). Reduced fears about the Greek debt problems have helped too, as have continuous upgrades to economic and corporate profit forecasts.
The latter is not solely an Australian event, and neither is it solely related to bulk commodities this year. FY11 and FY12, as well as shorter term FY10 forecasts, are still rising worldwide. This automatically and by definition provides positive momentum (as it makes shares look cheaper, all else being equal).
The best way to illustrate the effect of this on the intrinsic market value is: when the Australian share market reached for 5000 in early January this made the market look expensive on all metrics, based on what analysts had put on paper in terms of forecasts and valuations for the next few years.
Two months later, and with profit upgrades still flowing in, this market can potentially rise to near 5200 to look equally expensive as in early January. I think we all agree this is a big difference, and a big contributor to the positive momentum we've seen over the past month.
Last but certainly not to be dismissed, comes the fact that rising share prices ultimately bend technical indicators into a positive direction, no matter how badly they were looking in early February. And back then, as I pointed out at the time, things were looking pretty grim.
These past weeks, I have been specifically on the lookout for whatever technical or quantitative or other indicator commentators and experts would mention in their analyses and views, and it is unquestionable that most indicators are now in positive territory. Equally important: there's virtually no indicator around that is flashing “exuberance” or “overbought”, with the exception of maybe a few resources.
Add it all up and what we have is a cocktail of net positive results – in the absence of any sudden shocks, like a repeat debt problem in Dubai, or in Greece, or elsewhere, or political tensions flaring up between China and the US, or something similar.
Another reader asked me today whether I thought a correction was coming in the order of 5-7% and whether that then would be a good opportunity to start buying into some quality stocks.
I responded that I didn't immediately see a reason why a correction would be necessary -absent any left field shocks- because as long as investors remain confident current market forecasts for FY11 won't be far off the mark, they will confidently buy into stocks that look good value on those FY11 forecasts.
As things stand right now, those stocks are looking better value by the day (even without a 5-7% correction).
Of course, China could provide the trigger for another sell-off in the commodities space, but I still regard economic weakness in the US as the bigger danger this year. As things have developed these past weeks, investors may have to wait a few months before they will get a better insight into how strong/weak the US economy is without artificial support.
It is not excluded that those on the bullish side of the market will use the time in between to push share prices higher (after all, they have momentum, earnings upgrades and technical indicators on their side). If successful, this will infect more and more investors from the “undecided” group with their optimism.
I'd like to add that I have personally grown more uncomfortable with what may lie ahead for the US economy later this year. This remains a major worry as I firmly believe the world, and certainly financial markets, need a healthy US economy to perform.
For now, however, it doesn't look like this will be a major factor. Not now.
Readers should keep in mind that disappointments from the US economy do not necessarily take us back to the pre-March 2009 era. In November last year I published a story that calendar years ending with zero (like 2010) historically show a trend of below average performances (see below).
It's good to keep in mind that “below average” doesn't equal “absolute carnage”. Strictly taken, it doesn't even have to imply a negative return for the year.
With these thoughts I leave you all this week.
P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.
P.S. II – Those who have missed my recent analyses are invited to also read:
Weekly Insights: History Shows No Great Return For Year Zero (This is the story I referred to above)
Weekly Insights: Counting Market Headwinds
Rudi's View: Towards A New High For The Year?
Weekly Insights: Between Cheap And Fully Valued
Weekly Insights: How “Good” Was The February Reporting Season?
Rudi's View: Do We Have A Theme Developing?
Rudi's View: Watch Economic Momentum
Weekly Insights: How Much Should Investors Pay?
Weekly Insights: Lessons From 1994
