Return of the bull or bear-market rally?
JPM Investment Group director Alex Jamieson argues there is need for caution before getting too bullish about the recovery
With the Australian All Ordinaries having risen more than 40% since the March lows and the onset of new optimism in the marketplace, many investors and traders are wondering if this is a new bull market or a bear market rally with further downside still yet to play out. Whilst only time will tell, let’s take a further look at the facts to help formalize an opinion on where this might be headed.
When examining the Australian top 200 shares market at present we can see that it is fundamentally very expensive, with price earnings ratios at near all time highs of 18 times. This is well above the long-term historical trend of sub-15 times. So anyone who is buying shares today is paying a large premium of the share price, in the hope that earnings will increase dramatically in the coming year to justify the present cost.
Furthermore, at present more than 90% of the market is bullish on the outlook, as opposed to 10% which were bullish back at the March lows earlier this year. This high level of optimism is similar to the October 2007 highs prior to the global financial crisis, so it begins to make you wonder if the investors might be getting a little ahead of themselves.
On a global economic outlook, there is still a high level of uncertainty with the credit markets as a substantial number of credit markets are coming up for reset or maturity. These include the US residential home loans and commercial lending in the US and Europe, which are all coming up for maturity at the beginning of 2010, placing enormous pressure on the financial systems.
When examining the technical indicators, we have witnessed a classic bear market recovery similar of the 1929 crash. In addition, with October historically being a negative month and the 10-year cycle at the end of nine years traditionally being negative also, it does gives reason for one to be particularly cautious with the market – indicating that perhaps the level of optimism investors are feeling may be misplaced.
With all this in mind, a savvy investor may be inclined to go against the herd and view the market as a bear market rally. As such, it will be paramount to ensure your capital is protected over the next six months and allocate capital to asset classes that fare well in periods of economic uncertainty. It will also be important to resist the temptation of feeling as if you are missing out and jumping into the pot of enthusiasm – which may be short lived.
