Monday 6 April 2009
Current run-up still looks and smells like bear rally
Historical comparisons with 1929 may not mean that the market strength in the past two weeks is just another bear rally. But it does highlight that until the pressing structural problems in the global financial system are ironed out, each market run-up will still look and smell like a bear rally.
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Current run-up still looks and smells like bear rally
By Goh Eng Yeow
6 April 2009
Whatever the past 19 months has thrown at investors, they can’t complain that they haven’t been treated to some gratifying market rallies.
There have been six at last count since the bull-run ended in August 2007, some very powerful and impressive.
The latest started more than three weeks ago and shows few signs of relenting, having already hoisted the benchmark Straits Times Index by 23 per cent.
Its strength and resilience has added extra juice to the ongoing debate: Is this finally the start of a fresh bull-run, or just another bear rally luring in traders to yet another off-the-cliff plunge? After all there have been plenty of those as well since August 2007.
Going by previous run-ups in the past 19 months, the current run-up may yet turn out to be another dead cat bounce.
But the current run-up has been so powerful that some investors are willing to give it the benefit of the doubt and concede that it may indeed be the start of a fresh bull run.
The theory offers some help. A rally has generally been classified as a bull run once stock prices surge by more than 20 per cent. Yet other market observers, no doubt stung by the ferocious market swings during this economic crisis, continue to doubt if what we are seeing now qualifies as a bullish market.
True, some of the rallies in the past 18 months have been short and violent. Three lasted barely more than a week each before being snuffed out by fresh uncertainties in the wobbly global financial system. But it is the first of these bear rallies - the one that started on Aug 17, 2007, and ended on Oct 11 that year - that has given rise to so many misgivings about this run-up.
The 2007 rally sent global markets rocketing to record highs - the STI surged 25 per cent in those few months - but it turned out to be a false dawn.
Traders had been so mesmerised by the United States central bank’s swift action in cutting interest rates and China’s apparent willingness to open the flood-gates by allowing its citizens to invest overseas that they wrongly believed the worst of the stock market carnage was over.
But the harsh reality began to sink in. China put such investment plans on hold and global investment banks such as UBS and Citigroup were forced to write down billions of dollars on their portfolios as credit markets froze.
This sent the STI plunging 13 per cent in November 2007.
What had caused stock prices to begin their ascent in the current rally was positive remarks by bosses from major US lenders such as Citigroup, JPMorgan Chase and Bank of America that business for the first two months had been better than expected. Shares enjoyed a further boost when short-sellers scrambled to buy back stock they had borrowed.
Investors were also heartened by efforts made by the US Congress to lean on accountants to relax the ‘marked-to-market’ rules, which were widely blamed for eroding the capital base of banks.
These rules forced them to write down the value of their portfolios each time a fire sale took place on a similar asset.
The most recent run-up got a further boost from US Treasury Secretary Tim Geithner’s plan to clean up the tattered balance sheets of troubled US lenders by joining with the private sector to buy toxic assets. The sharper market observers reckon they have seen this movie before.
A rally was triggered in March last year by widespread relief that investment bank Bear Stearns had been sold to JPMorgan in a rescue engineered by the US Federal Reserve.
That rally ended in another plunge of course, but the rescue initially led many investors into believing that the Fed had drawn a line under the crisis with the Bear Stearns bailout.
That made the shock and dismay even greater when Lehman Brothers - a far larger investment bank - was allowed to fail six months later.
For many observers, Mr. Geithner’s proposal is merely a far bigger version of the Bear Stearns rescue efforts as he tries to purge the toxins from the banks without inflicting the pain of nationalisation upon them.
But as Shanghai-based economist Andy Xie recently pointed out, the Fed is complementing Mr. Geithner’s move, releasing more money into the market by buying up US$1.15 trillion (S$1.74 trillion) in US government bonds and loans.
While such fiscal stimulus may trigger a bounce in the global economy in the next six months, it may turn out to be a ‘head fake’, as a rise in consumer prices next year blunts the effectiveness of the stimulus measure.
A check on the price movements on Wall Street during the Great Depression also throws up an interesting illustration.
Barely a month after the great market crash in October 1929, stock prices shot up over 20 per cent within a fortnight.
The run-up lured investors into one of the biggest suckers’ rallies in history, as the bulls charged on for another five months before collapsing in the wake of a sharp contraction of the US economy.
Historical comparisons with 1929 may not mean that the market strength in the past two weeks is just another bear rally. But it does highlight that until the pressing structural problems in the global financial system are ironed out, each market run-up will still look and smell like a bear rally.
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