FYI | Aug 10 2009
(This story was originally published on Wednesday, August 5, 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).
A while ago I wanted to write a story of which the underlying message was: the bears are right, but they are oh so wrong. Unfortunately, a cocktail of circumstances happened across my path and the story was never written, but I think the central message still stands:
Sometimes the market simply wants to run.
It should have been clear from the onset in March that any sustained rally would have to take its lead from very selective data and events – and that is still the situation today. This is why I can sympathise with much of what the bears, the critics and the sceptics have to say from the sidelines, but at the same time I also believe they are not reading the market well.
Sometimes the market simply wants to run.
In the six months or so prior to March, all that investors could focus on was the dark side of developments. Worst case scenarios were bandied around. I lost count of how many emails were predicting the S&P500 would end up below 500 (or much lower) while comparisons with the Dutch tulip-mania, the tech-bust and the thirties seemed but logical.
Today the market is in the complete opposite mindset and thus commodities, equities and everything else that can be linked to increased risk and the future resumption of growth continues to rally. One market commentator on financial television today said he believed previous “panic selling” had now been replaced with “panic buying”.
I like that wordplay, because there is a lot of truth in it. Prior to March investors were not necessarily expecting the world was coming to an end, but many of them were forced to sell their shares nevertheless (or their shares were sold without them even knowing – see Storm Financial and other examples). Today, investors do not necessarily believe all is forgotten and soon the world will be a much better place than it has been since late 2007, but they are buying into the rally nevertheless.
There are many reasons why investors are buying these days. FoMo – the fear of missing out is one of them. Too much cash on the sidelines while the long awaited pull back never comes – that’s another one. Short covering – surely every time the next technical resistance level pops up a certain part of the market feels the need to go short, only to see the rally extend further?
Plus let’s not forget one of my old market observations: nothing attracts as much as rising share prices.
One only has to look at a price chart for the past two weeks or so to see how relentlessly steep the global rally has been. Some commentators will tell you this is what excess liquidity does to the prices of financial assets. Last week, Marc Faber drew a parallel with equity markets prior to and just after the year 2000 (Faber is the publisher of the widely lauded Gloom, Boom and Doom report). Faber’s reference price charts look very steep too.
There are many misgivings and false truths about financial markets. One of these is that investors should “buy low and sell high”. Wrong. If you try to buy low in this type of market you risk ending up with a loser stock, while all the rest is running away from you. The correct mindset, and I am borrowing this from US trader Dennis Gartman (publisher of The Gartman Letter), is to “buy high and sell higher”.
What Gartman tries to explain is that momentum is a trader’s best friend – always. What I am trying to say is that sometimes momentum is all a market has to offer, for the short to medium term – whether you are an investor or a trader.
One financial commentator put it as follows: there is no fundamental justification for this steep rally, but neither is there clear support from the technical side, so all that is left driving share prices is momentum.
It becomes both confusing and amusing when journalists and commentators try to find fundamental justification for what is happening. The most obvious error that is being made – over and over again – is to seek some kind of a predictive prowess behind market movements. The share market has no ability to predict anything – it acts like a bouncing ball, constantly trying to find out how long and how high it can bounce, until it gets knocked back, or runs out of energy.
Only then will momentum decisively reverse.
It always amazes me how experts can say things like “the oil market is up so that indicates there is growing demand out there” – and they manage to say it with a straight face too. On the other hand, am I the only one who finds it amusing that expert after expert after expert appears on financial television stating there is no demand for oil, yet prices are back above US$70 and seemingly on their way to US$84/bbl?
The US dollar Index broke through technical support this week. This might well turn out to be everything an investor needs to know for the time being. The risk-growth theme can still last much longer than it already has. If my observation is correct, a growing part of the market is now convinced the months ahead will see a continued flow of improving economic data and events – this means that pure fundamentals can remain in the fridge for a while longer, momentum will carry this market much further, thank you very much.
The best advice anyone can provide investors with is to buckle up and hook onto this train. To put it in Gartman’s words: make sure you buy what goes up and you sell it at a higher price – don’t buy what goes down, because you don’t know how low it might go.
Of course, ultimately this market will do what it always does: run too hard, too fast, too long, too high.
But as I have said before, at this point in the cycle forecasts for global growth and for corporate profits are on the rise, and this will keep the positive momentum going underneath this market. Remember: forecasts not facts support share prices. Facts are only important in how they impact on forecasts.
So as long as FY11 forecasts remain high, and maybe even rise further, any pull back should be temporarily and relatively brief.
Until we get to the point that shares look expensive even on FY11 numbers. This is already the case on individual metrics, but not yet for the market as a whole.
For those investors who try to look past current market momentum: be aware that most defensive stocks still look relatively expensive. Though, I readily admit, I was surprised to find out that Navitas ((NVT)) offers a forecast dividend yield of 7% on FY11 numbers (and that while the stock is trading on a FY11 PE of 14.4).
Also, banks have started to receive recommendation downgrades again after a tremendous run since stockbroking analysts started turning more positive on the economic cycle and thus on bank earnings (less provisions).
Earlier in the week, colleague Greg pointed out the banking team at RBS had arguably been the most bearish in the market, and now had joined the likes of Citi and GSJB Were with a positive view on the sector. The last bear changing his coat?
(The banks still look cheap on FY11 metrics, by the way, with PERs of 10.5-11).
On Monday, Daniel Goulding (publisher of The Sextant Report), who has stoically persisted in his negative view throughout this rally, mentioned the fact that ueber-bear Gerard Minack has turned more positive on the share market’s outlook as a more appropriate case of the last bear in the market changing his view.
The last time I remember Minack changing his tune was at the same time his then colleague Stephen Roach did the same thing. Back then, in 2006, it proved the prelude to a temporary pull back from elevated highs. But ultimately the up-trend would simply continue.
If history repeats itself, I think it will do in similar fashion.
With these words I leave you all this week,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by Greg, Andrew, Chris, Rob, Joyce, George and Pat)
P.S. Something to think about provided by the institutional desk at GSJB Were this week: July’s 7.6% gain proved the best performance for the Australian share market since December 1993 and the fifth highest monthly rise in twenty years.
But here comes the flip side: only in December 1993 has a gain of 8.2% been followed up with another positive performance – up 6.2% in the following January. On all other occasions the share market took a step back the following month.
On two occasions – September 1989 and January 2003 – the subsequent step back hardly registered, with monthly losses of 1.54% and 1.80% respectively. On two other occasions, however, the share market gains were subsequently wiped out in the following month, with losses of 5.6% in November 1993 and of 4.5% in November 1991.
Hey, I hear you ask, when one month gains 7%-plus and the next month loses only 4-5%, how can this wipe away all gains? It’s pure mathematics. Think about it. I am sure you’ll figure it out.
