News

Bulls and bears battle for supremacy

23 April 2009

As ever at turning points, there are strong arguments to be made on both sides. Whether you side with those calling the early stages of a new bull market or throw in your lot with those who see just a bear market rally is as much a reflection of your own personality and temperament as the facts themselves, which can be pointed in either direction equally plausibly.

The bullish argument is broadly-speaking this:

• The fundamental backdrop for equities is worsening at a slower rate than it has been recently. Unprecedented government stimulus should start to have an effect by the end of 2009 and the market will anticipate this by around six months. Earnings revisions, while still negative, are declining more slowly than before.

• Some of the most negative indicators, such as still sharply rising unemployment, tend to lag improvements in the economy so should be disregarded by forward looking investors.

• Investor sentiment was extremely negative at the bottom in February which is why even a glimmer of hope was able to galvanise the market. Bull markets always “climb a wall of worry”.

• Commodity prices are rising. Traditionally the price of things like copper and oil turns a few months before the stock market. Copper, in particular has risen sharply from around $3,000 a tonne at the beginning of the year to $4,500 or so today.

• The amount of cash on the sidelines and waiting to be invested is historically very high so, if investors do decide that there is more to this than a pause for breath in a still falling market, a wall of money could push prices considerably higher.

• There is plenty of value to be realised. Measures like the price-earnings ratio, while not at absolute rock-bottom levels, are cheaper than they have been for many years. According to Fidelity’s Anthony Bolton, shares are cheaper compared with the value of companies’ net assets than they were at the bottom of the market in 2003 and 1993.

• History suggests that it has usually paid investors to buy shares after “lost decades” such as the last ten years in which shares have underperformed badly. There are no guarantees that history will repeat itself, but the odds of decent returns going forward are markedly better than after a long period of rising prices.

Given this combination of factors, it is unsurprising that markets should have bounced so convincingly in recent weeks. The S&P 500, for example, has risen by 29% since it hit bottom on March 9. On this side of the Atlantic, the FTSE 100 has gained 17%. Emerging markets have risen almost as fast as American shares, up 27% since the start of March.

What is so fascinating about the market today, however, is that there are as many arguments for why the market could fall back from today’s level as there are for why it should continue pushing ahead. Here are some of them:

• Other major stock market declines have been punctuated by sometimes significant rallies which have built up investors’ hopes only to dash them again when the surge ran out of steam. During the great crash of 1929-1932, for example, there were numerous rallies, including one which saw the market rise by 48%. In the long Japanese slump that followed the peak of the Nikkei index in 1989 and still continues today, there have been four rallies which have seen shares rise more than 50% above their low point.

• Economic news is extremely poor. In both the US and Britain, unemployment continues to rise. The unemployment rate in America was 8.5% in March and more than 2 million people have lost their jobs since the turn of the year. In Britain, unemployment is widely expected to rise above 3 million again.

• House prices continue to fall on both sides of the Atlantic, despite glimmers of hope that the worst may be over. Even if price falls are slowing and buyers are starting to become tempted by lower prices, activity remains at very low levels.

• Inventories held by manufacturing companies have fallen to low levels, but sales have fallen even faster so the hope that a small upturn in demand could get factories humming again looks optimistic.

• Recovery, far from being a rapid V-shaped bounce, could be anaemic if consumers decide that after a decade and more of excessive borrowing they need to nurse their household balance sheets back to health. Developed economies which have been heavily dependent on consumer spending could be slow to recover and the export economies which supplied them in the boom years will continue to suffer as a result.

So finely balanced are the arguments on both sides of the debate that only the bravest of investors would feel confident that they know which way shares are headed in the short term.

Source: Tom Stevenson, Fidelity