Equities: Idyll or excess?

Global Agenda: The markets have pretty much wound down for the holidays, but when the activity picks up again in the new year, January promises to be an interesting month.

By PINCHAS LANDAU
Australian elections mining stocks 311 AP (photo credit: Associated Press)
Australian elections mining stocks 311 AP
(photo credit: Associated Press)
Wednesday was a pretty regular day in the stock markets of the Western world. In Europe, as in North and South America, most markets were higher. True, a few key Asian markets continued to display weakness, as they have done of late, but they are the distinct minority.
Most important equity indices, in both the developed and developing worlds, made new highs for the week, month, year and, indeed, the entire period since March 2009, when these markets hit bottom. In most cases, these indices have regained some 60 percent to 70% of the total fall they suffered during the bear market of 2007-2009.
Just to give some indication of the intensity of the market’s uptrend, we may note that the S&P 500, comprising the larger companies traded on US markets, rose on 14 out of the 16 trading sessions through Wednesday, while the market as a whole, reflected in broader indices, has risen in 12 of the last 14 weeks.
Looking ahead, the big banks, investment houses and brokerage firms are virtually unanimous that global equity markets will continue to rise in 2011. How could it be otherwise: when money will remain either virtually free or at least very cheap; when corporate profits are set to rise further; when economic growth will be positive, even if not stellar; and when the wellbeing of the equity markets is now officially considered a key goal of economic policy, because these markets both reflect and create the wealth and hence the economic well-being of the public? Well, it could be otherwise and, in the view of the bears, it will indeed be so. Battered but far from beaten, and if anything more defiant than ever, the bears are unimpressed to the point of scorn and derision, by the ongoing rise in the equity markets.
Although their numbers are small, the thing to note about the bears is that they – not the herd-following “strategists” in the big Wall Street houses and their European counterparts – were right about the housing bust, the market crash and the recession. That is no guarantee that they will be right this time – after all, they got 2010 pretty spectacularly wrong – but it should at least grant them a hearing.
The larger family of bears are the technical analysts. The prevalence of pessimism among the “techies” is so great that it has encompassed even the big banks. For example, on Wednesday, the technical analysts at Citibank issued a note pointing out the strong similarities between the strong rebound of 2009-2010 to the rebounds following several other major downturns, in the 1930s, 1970s and even going back to the 1907 crash.
A particularly chilling point was that these rebounds all peaked at the beginning of a calendar year, on or about January 3 – to which one could add that there is a wider phenomenon of market rallies and even major booms peaking in the first days or weeks of the calendar year.
But timing is hardly the issue here. The main issue the technical analysts have with the markets today is that they are massively overbought, to a degree almost unprecedented in history.
A long list of indicators, relating to the internal strength of the market (measuring things such as volume relative to the number of rising issues, numbers of shares making new highs, advance/decline ration and assorted other indicators that nontechies dismiss as “voodoo”), as well as a broad range of sentiment indicators, are all at extreme levels. The latter group include the views and actions of individual investors, independent advisors and mutual-fund managers; all these groups are exceptionally bullish, to a degree seen only at or near major market tops.
That this state of affairs has continued for weeks, and thus become steadily more extreme, does not faze the bears. On the contrary, in their view it simply means that when the market breaks and the trend turns, the fall will be bigger and stronger.
The thing that really gets them is that so many different indicators are moving into such extreme states at the same time – which they say is almost unprecedented.
But the techies are not alone. There are respected fundamental analysts, such as David Rosenberg and John Hussman, who produce detailed analytical research explaining why they view the economic data in a very different light from their mainstream peers at the big houses, and why they are convinced that the rally in the markets is a liquidity-driven phenomenon that will end very badly.
It is common to hear comments such as “everyone is entitled to their opinion.” Often this merely means “I think that’s garbage, so I’ll pay no attention.” However, the degree of complacency being displayed by equity-market participants (although certainly not by their bond-market colleagues) is itself so extreme that it serves as a warning indicator in its own right.
The markets have pretty much wound down for the holidays, but when the activity picks up again in the new year, January promises to be an interesting month.
landaup@netvision.net.il