FYI | May 25 2009
(This story was originally published on Wednesday May 20, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).
Regular readers of my comments and analyses know I have a long standing belief that too many financial reporters and market commentators are too focused on semantics and petty little details that only distract investor focus from the more important issues. The Big Question last year was whether Australia would experience a recession. Before that it was whether the US was in recession. In between there was a rather brief time when the same question was directed towards China.
This time around the Big Question is whether share markets are experiencing a bear market rally – or not.
In my view there has always been little doubt about the correct answer: it was “yes” at the end of 2007, and it hasn’t changed since then, even though the question has.
The fact that Edwin Coppock’s Indicator is likely to confirm in about ten days from now that share markets have seen The Bottom for the foreseeable future doesn’t change anything, in my view. Share markets are 30% and more higher than they were in March, circa 23% in case of the Australian market; that’s a lot of bandwidth to play with without ever having to see those March lows again.
Mind you, what goes up by 30% only needs to go down by 25% to get us to the same level again.
I don’t want to engage in the same war of semantics I was criticising in my opening sentence, but both the severity of the problems that got us here, the fact that no infallible solution is yet in place, plus historical references and what I would regard as logical consequences for the near future: increased taxes, increased legislation and continued deleveraging by companies and consumers – this all tells me there aren’t going to be any fireworks in terms of economic growth for some time to come. Low economic growth means low profits for companies.
Ultimately, share market valuations can only withstand the pressure from low corporate profits for so long. Investor risk appetite (hope) is not an eternal given. Having said all of the above, if black swans and other exogenous shocks to the system remain absent, share markets could potentially still rise further from here, despite the troubled economic outlook (don’t get carried away by the “green shoots” theme; the economic outlook remains troubled).
So are we still in a bear market?
If the term “bear market” only refers to “falling asset prices” it would at this point be debatable. If, however, the term is used to signal share markets are still far from “normal programming”, let alone from what occurred between 2003-2007, I’d say show no restraint, use the term in spades.
Does it matter though?
Hong Kong based, but Swiss-born, analyst, market commentator and strategist Marc Faber, best known as the publisher of the Gloom, Boom and Doom Report, asked the question to his readers this week: does it matter?
While commentators and experts worldwide are debating whether equities are experiencing a bear market rally, or possibly something else, markets are up by 30% and many individual shares are up by much more than that. Some of those gains could be in your pocket if you’d decided to participate instead of waiting for how the public debate will end, suggests Faber.
He is, of course, dead-right. Equity markets might have stopped spiralling down, the economic uncertainties that are currently clouding the outlook are likely going to stay with us for years. This will probably translate into higher volatility, more risks and uncertainties, and it may possibly cause share markets to revisit the March lows at some point.
The Speculative Investor, whom I have mentioned before, reported this week US equities in the present bear market have since January 2008 moved in a similar fashion as they did in the initial stages of the 1937-1942 period. I am repeating this piece of analysis because it is the first time I came across a comparison with the late stages of the Great Depression (it’s usually the early stages people refer to), but also because it fits in with the theme of this week’s editorial: back then, US shares fell 50% over 57 weeks, then they rose again in two stages to minus 20%, range traded for a while, then fell back to below minus 30% again, surged again to the aforementioned minus 20% level, and pretty much stayed there for almost forty weeks.
The latter is an assessment on the basis of net index movements as the market went up and down on a weekly basis, but effectively didn’t go anywhere on a net basis. Then a sudden fall took the market back to a loss of 40%, after which a gradual recovery to minus 30% followed. This goes on, and on, and on. At the end of the period, 300 weeks from the zero point, the index had fallen back to minus 50% – the level reached 250 weeks earlier, and a recovery to a level above 40% below the starting point in 1937 had begun.
The share market will continuously try to anticipate better times ahead. Investors who intend to wait until all the clouds have gone, until all answers have been answered, and until no major risks remain in the game, are bound to miss out on any of the gains that can possibly be made. Apart from the fact that they will probably have to wait years for all of these conditions to be met.
This is why I like to respond with “yes” to the much asked question these days. Because it keeps investors prepared for what lies ahead (instead of giving them false hope that 2003-2007 is about to repeat again).
David Rosenberg, previously at BA-Merrill Lynch, but nowadays Chief Economist & Strategist at Canadian based investment manager Gluskin Sheff, and equally a source of analysis and market insights who has featured regularly in my writings, used his first daily market report in the new job on Monday to state that “my place of work has changed, but my overall views have not”.
Rosenberg has no doubt at all that what we have experienced since early March is a classic example of the bear market rally. For those investors looking to play the momentum trade, his advice is: “What we know about history is that the sectors that led the downturn are never the ones to emerge as leaders in the next sustainable bull market.”
Guess which sectors have been in the lead during this rally? Financials, consumer discretionary, materials and industrials – the same sectors that were also in the lead during the downturn.
Says Rosenberg: it remains yet to be seen whether the March lows will hold or not, but unless the US share market manages to bounce and rise above the 200-day moving average (it failed last week and lost a few percentages of the March-April-May rally since), we would have to assume the market is now on its way to retest those March levels (Rosenberg’s assessment, not mine).
At a minimum, advises Rosenberg: take profits.
Plus here are some of his observations thus far during this bear market:
– The average length of the testing phase is 53 calendar days and 38 business days (versus 45 calendar days and 33 business days for the interim bear market rallies).
– On average, the S&P 500 undergoes a correction of more than 20%.
-The sectors that led during the rally, subsequently corrected most during the selloff. This means the above mentioned financials, consumer discretionary, materials and industrials should underperform in the next few months, while health care, consumer staples, utilities and telecom services should emerge as the new leaders.
– Market volatility more than doubles, on average.
– Bonds rally, with the 10-year Treasury note yield on average down nearly 15 basis points.
– The flight-to-safety during these periods means the Canadian dollar declines (on average by 10%), while the trade-weighed US dollar rallies more than 6% (Unfortunately Rosenberg does not give any indication about the Aussie dollar, but investors can draw a comparison with the “loonie”).
– Commodity prices decline an average of 15%, again as cyclical trades unwind.
– Corporate spreads (Baa) widen an average of more than 60 basis points; Rosenberg says it is very important to be focused on high-quality “paper” during these market testing periods as high-yield spreads widen, on average, by more than 300 basis points
– gold tends to perform quite well during both the bear market rallies and the subsequent selloffs.
To recap: what works best during the retest? Answer provided by Rosenberg: Health care, staples, utilities; high quality bonds; the US dollar.
Those investors who don’t want to ride the ups and downs of market momentum should still realise “timing” remains as important as picking high quality stocks in this market. The closest thing to what used to be known as a “Buy-and-Hold” investment strategy is an active portfolio with large, solid dividend paying blue chips. Buy at levels you feel comfortable with, and don’t stare yourself blind at share price movements in the short or even medium term. You have just turned the share market into an ATM. Treat it that way.
And if, years into the future, the share market is back at 3100, then you’ve enjoyed your dividends regardless.
Those two last paragraphs are by me, not Rosenberg, by the way.
With these thoughts I leave you all,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by Greg, Andrew, Chris, Grahame, George, Joyce and Pat)
P.S. I – as flagged a while ago, we are about to add more bells and whistles to the Stock Analysis section on the FNArena website. Should be up and running any time now. In essence, we are about to add more valuable insights into companies reporting in a currency different from the Aussie dollar.
P.S. II – the Special Report into the growth outlook for Australian companies I mentioned last month is finally in its final stage. Just a little bit of extra patience is required. The good news is the Report will be better and more in-depth than I envisaged originally. Also, we are working on making this a permanent feature on the website. Once this is up and running, and this should not be far off, you will all be able to see why I am excited about adding this feature to our service.
P.S. III – following on from my Weekly Insights this week (see “Lessons From China”), resources analysts at UBS have just returned from a trip to China with the conclusion that all growth and demand inside the country appears to be government stimulus driven. Also, the following chart, taken from Gregory T Weldon’s “Money Monitor” reveals why exactly iron ore imports have surged as much as they did over the previous months (similar charts can be drawn for copper and for crude oil). Apologies to those readers who read this editorial through a third party channel – the chart may not be included.
