If you’re going to ride a bull watch out for the kick
How long the current rally will continue and whether this really is the start of the next bull run are questions which everyone is mulling over. What we should also be asking is what changed in the last 5 weeks to justifiy a 30% rally?
For all the talk of global cues and increased risk appetite, no one has convinced me that this rapid advance isn’t irrational and therefore likely to correct itself. Now obviously this is part of a global rally just like it was a global crash. This just begs the question of whether the the global rally is sustainable or can be justified logically?
I think not and I say this because 18 months of absorbing bad news seems to have made markets all over the world, and particularly in India, immune to it. Bad news is no longer newsworthy but good news is trumpetted from the rooftops. For example; March YoY export decline was the worst on record (India), motors sales last month were the worst on record (UK), recent unemployment figures were the worst for 6 years (US). All these stories demonstrate a continuing global decline but had minimal impact on the markets. However, the same markets rallied when the G20 re-announced existing IMF funding plans.
In the real economy we are seeing a slowing of the decline not recovery. Globally the US is still in bad shape and the UK is set for the longest recession in memory. Continental Europe is hurting and exposed to melt-down in Eastern Europe and exporter nations in Asia, dependant on the US and Europe are still contracting. All in all the global economy, and therefore India’s export market, will continue to decline for some time. Despite this, the market is rallying aggressively in the run-up to an earnings season expected to be the worst for years, if not on record.
Now bull markets often start while the economy is still worsening, so this may well be the first rally of the next bull market. However because the start of bull markets often come well before the fundamentals justify them, they are nearly alway characterised by a dramatic correction after the first rally. This means that people who jumped on late get a nasty kick as the correction bites.
Irrespective of whether or not this is a bear market rally or the first wave of the bull market, a correction is becoming overdue and a clue to the possible path of this correction comes from shape of the advance; its pace and consistency suggests an aggressive one. Whether this means the markets will set new lows in 2009 is unclear but it should be remembered that a 34% advance only needs a 25% decline to erase it, so it st certainly still possible. I am reluctant to say for sure whether or not this is a bull, but it is certainly a dangerous time to start riding with the short term risks heavily on the downside.
