Monday, 21 April 2008

New Bull Or Another Bear Market Rally?

Back in January after the market rallied almost 12% from the January 22nd lows I cautioned 'beware of the suckers rally'. That turned out to be fairly accurate. So what to make of the latest bout of market euphoria on the back of the Federal Reserve's new role as corporate welfare provider and some admittedly very respectable earnings results from non-financial companies?

Personally I think there's not much to make of it at all, it's just another bear market rally. At times like these I think the words of John Hussman are worth reiterating:

It is crucial to recognize that the market downturns associated with recessions are never one-way movements. The basic feature of bear markets is that they maintain the hope of investors all the way down. The stock market often rides the Bollinger band lower, becoming more and more oversold, but will then unpredictably clear those oversold conditions by producing explosive advances that are fast, furious, and prone-to-failure.

I find the claims that the market is looking over the valley and has discounted all the bad news to be little more than wishful thinking. Economic Data continues to get worse and banks continue to write down asset values, slash dividends and significantly raise their loan loss reserves.

Today alone we hear that Bank of America reported a -77% drop in profit whilst National City is raising $7 billion in new capital and slashing it's dividend just to stay afloat. The US consumer continues to struggle with the headwinds of higher food and energy costs, rising unemployment, tighter credit conditions and falling house prices. B of A's CEO Ken Lewis put it well today commenting on his company's results:

"We remain concerned about the health of the consumer given the prolonged housing slump, subprime issues, employment levels and higher fuel and food prices,"

The sheer masses now proclaiming that the lows have been seen and that a new bull market has emerged should be enough to frighten anyone with a contrarian perspective.

Another false platitude doing the rounds is that the market at current levels is cheap. Such statements are usually made with reference to forward P/E ratios. Forward P/E's as mentioned here many times before are practically useless when changes in the earnings cycle are occurring and earnings visibility is poor. Again it is worth listening to John Hussman who writes in this week's missive:

If the market trough a few weeks ago represented a final bear market low, it would be yet again at the highest level of valuation in history for a bear market trough, and the lack of compelling improvement in market action from the recent low will also have delayed a favorable shift in the Market Climate beyond what we normally observe at the start of a new bull market cycle.

If Hussman's words sound at odds with most mainstream financial markets commentators that's because Hussman looks at trailing earnings and profit margins. On both metrics stocks are nowhere near cheap.

However as always I keep my mind open to all possibilities including the one that says the bear market lows have been seen. However if that is the case, we are setting up for some very mediocre returns over the next few years for the stockmarket.


Deano said...

I'm wondering if we are about to get another sharp downturn given the central bank rumblings round the world over the last 24 hrs. UK has just repoed a billion quid worth of MBS, and the RBA has just done a billion 1 yr repos over Friday and Monday, and the Fed has auctioned 50 bill of loans to commercial banks overnight.
We are all sitting here at work wondering if they know something of great market significance that we dont. This equity market rally might have got some traction but it will only take one more large bank/finance insto to fall over and the share market will shit itself again.

The Fundamental Analyst said...

Yeah it wouldn't take much to send markets tumbling and with the continued deterioration in credit markets, the risks seem to be firmly stacked on the negative side of the ledger.

LIBOR is at alarming levels, 30 year mortgages in the US are on the rise again. Mounting evidence that banks don't want to lend to one another. More writedowns, dividend cuts, and rising bad debts. It's going to get worse before it gets better.