Technicals | Feb 01 2024
By Daniel Goulding
Don’t accept imitations!
Australia's benchmark share market index has carved out a new record high, prompting some experts to declare that the bull market remains alive and well. Before making any hasty investment decisions, however, make sure you read the fine print. The definition of a bull market can vary, and so can its implications for the future.
Although the term has been in the financial lexicon for more than 100 years, there is still no widely agreed-upon definition.[1] The one that is commonly cited is when a major share market index rises by 20% or more from a recent low. [2] While this definition is mathematically elegant, it does not necessarily capture the essence of what a bull market is.
Bull markets are characterised as a time when stocks have been rising, and there's an expectation that they'll continue to rise in the foreseeable future. There's a sense of confidence or optimism about the future, which arbitrary price changes cannot measure.
During the bear market of 1929 to 1932, the Dow Jones Industrial Average fell almost -90% in just three years. Throughout this decline, there were five rallies of more than 20%, each lasting only a few months.[3] These rallies were merely countertrend rallies within the context of a bear market, and it's difficult to categorise them as anything else.[4] Bull markets deliver higher returns with less volatility than bear market rallies.[5]
Qualitatively speaking, we can say that investors remain nervous and uncertain during a bear market rally, while they are confident, sometimes brazenly so, during a bull market.
It is also important to understand that a significant rise in a market index does not always equate to a rise in investor confidence. For example, Australia’s benchmark share market index, the S&P/ASX200 Index, measures the performance of only the 200 largest stocks by market capitalisation, representing less than 10% of all listed companies. The larger the market capitalisation of a company, the greater its weighting in this index.
The ten largest companies, therefore, make up almost 50% of the ASX 200.[6] If this index is moving higher on the back of strength in the largest stocks, while investors are abandoning most other stocks, investors are anything but confident about the outlook.
Exhibit 1 compares the performance of the ASX200 with the S&P/ASX Emerging Companies Index since 2022. The latter index measures the performance of up to 200 micro-cap companies.[7] As micro-caps are generally more sensitive to economic and liquidity considerations than the mid- to large-caps stocks that dominate the ASX200, they arguably provide a more accurate representation of the state of investor confidence. While the ASX200 may be sitting at all-time highs, microcaps are down -30% from their record high, telling a very different story.
Exhibit 2 compares the performance of large, mid, small and micro caps since 2022.[8] For the past two years, investors have increasingly avoided the riskier echelon of the market, instead preferring to invest in the largest and “safest” stocks. This suggests that while investors are not outright bearish enough to push the entire market lower, they are also not particularly bullish.
This type of extreme disparity between the various capitalisation indices is typically observed during choppy sideways markets or significant market tops. Fortunately for investors, my technical work suggests that it is the former environment.
Although the ASX200 will likely breach 8000 this year and could head as high as 8500 to 8700, it will be large-cap stocks doing the heavy lifting. Most other stocks will watch the rally from the sidelines or even decrease in value. Eventually, the large-cap stocks will also correct, and the index will return to current levels by late 2024 or 2025.
Call this a bull market if you wish. Just don’t conflate this label with the idea that most stocks are bullish. Caveat emptor, let the buyer beware!
Daniel Goulding is a technical analyst with over 20 years of experience. He is the publisher of The Goulding Letter on Substack and, previously, The Sextant Market Letter. His Twitter handle is @CopernicusASX. He previously worked as an Authorised Representative of the Townsville branch of RBS Morgans, and later Grow Your Wealth Financial Services Townsville.
This material was prepared by Daniel Goulding and represents the views and opinions of the author. It does not constitute investment advice. My work is didactic in nature. You should consult a licenced financial adviser if you require professional assistance with your portfolio.
Footnotes
[1] The earliest known written use of the term "bull market" was in 1891, according to the Oxford English Dictionary. The terms "bull" and "bear" have been used since at least 1720, when Alexander Pope used them to describe the South Sea frenzy.
[2] The convention is to use closing prices rather than intraday lows and highs for this calculation. I stay with convention unless otherwise stipulated.
[3] The average magnitude and duration of these rallies were 32% and 70 days, respectively. Rallies of this magnitude and duration are par for the course during nasty bear markets. During the 2000 through 2003 bear market for the S&P 500, there were 3 bear market rallies, averaging 21% and lasting 61 days on average. Australia’s worst bear market occurred from 1970 through 1974. There were three bear market rallies, averaging 36% and lasting on average 4 months. I used monthly high and low figures for these calculations as there is scant/unreliable data for Australian shares before 1980.
[4] Some analysts designate these bear market rallies as “short-term” cyclical bull markets, as opposed to “long-term” secular bull markets. Theoretically, it does not make sense to associate these short-term moves with the psychology that is evident during a bull market.
[5] See, for example, John Maheu, Thomas McCurdy & Yong Song, “Components of Bull and Bear Markets: Bull Corrections and Bear Rallies,” Journal of Business & Economic Statistics 30, no. 3 (2012): 391-403.
[6] Imagine constructing an economic survey of the average household in Australia but seeking responses only from the wealthiest suburbs and, in turn, giving extra weight to responses from the richest households.
[7] The S&P/ASX Emerging Companies Index is also capitalization-weighted, but it is less imbalanced than the ASX 200 because its top 10 companies only make up 15% of the index. Therefore, I consider it to be a more just representation of the Micro-cap universe.
[8] I use the S&P/ASX 50, S&P/ASX MidCap 50, and S&P/ASX Small Ordinaries Indices to depict the performance of large, mid and small caps.
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