Don't get fooled by the stock market bounce
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Associate Editor
David Stevenson Mar 20, 2009
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The surge is likely to be temporary
Can stockmarket investors finally breathe again?
Before today, the MSCI World market index had risen for eight days in a row - the longest run of gains since 2006. So there's no doubt a bounce is underway. But is it the real turning point?
Not the way I read it. The current rebound may run for a little longer. But long-term, share prices could still have much further to fall...
This is not the bottom
"It's a funny old world", says Societe Generale's Albert Edwards. "It only takes a few days of equity markets rallying for investor sentiment to turn decidedly more optimistic. Spring hopes are rising like sap in the freshly budding trees".
Global share prices, as measured by the MSCI World index of 23 developed countries, have enjoyed a 15% rebound since 9 March. What's more, the stocks driving this recovery have been the long-term pariahs, like raw material producers and yes, those banks.
Now, it's always worth remembering how percentages work. It's a statement of the obvious, but if the price of an asset falls by 50%, it then needs a 100% gain just to return to where it started. Despite their latest recovery, mainstream world shares are still down almost exactly 50% from their peak of about 18 months ago.
But even so, that's still a decent bounce. So is this a sign that stock market radar screens have detected an end to the planet's financial woes - or is it just yet another false dawn?
As John Stepek pointed out earlier this week, quite a few high profile names have being calling the bottom of the market, like Anthony Bolton, former uber-bear Jeremy Grantham and, of course, the legendary Warren Buffett: Markets haven't bottomed yet – but some stocks are worth buying.
But if you read the small print, you'll find that this isn't exactly the first set of such utterances from some of these bullish converts. Buffett has admitted that he "did some dumb things in investments during 2008".
Further, Grantham reckons there's also "still a 50/50 chance of crossing 600 on the S&P 500". As this major US index currently stands at 784, that implies a further 24% drop which would drag down the rest of the world, too. It would also mean that what we're now seeing is just a bear market rally.
Even so, how long might it last, and is it worth a 'trade'?
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As this is the biggest financial panic since the Great Depression, it makes a lot of sense to find out what actually happened then. And from the peak on 3 September 1929, the Dow Jones Industrial Average plunged almost 90% in less than three years.
But within that time there were some quite chunky bear market rallies. Andrew Garthwaite and his team at Credit Suisse have identified six periods when American shares seemed to be recovering, ranging from a near-50% bounce between November 1929 and April 1930 – after the market had almost halved – to a 25% pick-up between January 1932 and March 1932. The average rally was 30%. But on each occasion, within a matter of months, or even weeks, all the bulls' hopes had been well and truly dashed.
Bear market rally indicators to look out for
This time round, bear market rallies have been averaging just 14%, with the largest being 24%. Garthwaite has five "bear market rally indicators", all of which need to show green before he's confident that a decent-sized bounce is in store. At present, just three are flagging a stockmarket recovery: very high cash levels, some US lead indicators – which hint where the economy is going next - looking a bit brighter, and credit markets improving.
The other two are a peak in unsold American houses and "investor capitulation". And though there have been slight signs of the former, not to mention a fair bit of investor gloom (Are shares now yesterday's story?), "the bottom line", says Garthwaite, is "we think this rally could easily run another 10%, but the full 30% bear market rally (let alone 50%) is unlikely".
Buying in now could be risky - but some stocks look cheap
In short, buying in now could prove to be very dangerous. Because after this rally, stock markets could fall much further before finally hitting their absolute trough. As we've regularly pointed out, plunging company profits mean that share valuations still aren't cheap.
Russell Napier of CLSA, who has predicted the market's moves as well as anybody, reckons the current recovery in stock prices might even run into 2010. But he repeated this week that then: "the bear will return and we will see US equity prices" – which will drive the rest of the world's markets - "bottom at almost 50% below current levels… sometime around 2014".
And another key indicator is showing no signs of recovery. Between three and six months before the final, real upturn in stock prices, the corporate bond market – a bellwether of the health of companies' finances – needs to bottom out. But there's no sign of that happening yet, more the opposite. Corporate debt markets still look stressed out.
Edwards sums it up: "Like all bear market rallies, the same old clap-trap is wheeled out about the market pre-empting recovery 6-9 months ahead and valuations being too cheap to ignore. But with the US equity market still far above bargain basement level, being too early could be very painful indeed".
That's not to say that individual stocks aren't cheap – we point to a few decent candidates in the latest issue of MoneyWeek (out today – get your first three issues free). But as we've stressed several times already, now's not the time to be chucking your "buy and hold" money into a FTSE 100 tracker.
Our recommended article for today
Coal is out of fashion right now. But Tom Bulford thinks there will be a revival in coal's fortunes. Here, he explains why - and why it could be a good time for investors to revisit commodities.
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