First with Financial Comment from Arabia

Financial markets looking for a new direction

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china_0914009US equities have surged 60 per cent from the lows of March leaving bearish commentators who called an end to the rally at 38 per cent with egg on their faces.

Like the little boy who called fire once too often there is now the danger of ignoring the obvious call and getting burnt alive.

Indeed, we know this is going to happen. No stock market goes up in a straight line for long, and even a powerful new bull market is going to have corrections and pull backs. This is just the history of markets and a matter of public record.

Momentum slowing

Over the past few weeks market volumes have been weak on the days that the market is up. Lower trading levels mean buyers are fewer and fewer on the ground. In short, the long rally is finally running out of steam.

What is needed to send the market higher is another biggest-buy-of-my-career by Warren Buffett or perhaps some dazzling economic data. There is not much chance of a super set of company results as 93 per cent of S&P companies have reported earnings.

You could even tentatively suggest that the risk is to the downside. And with industrial output picking up strongly from low levels now the baton is perhaps being handed back to the financial markets as the place to look for renewed weakness.

Could it be that the optimism about a recovery that has compounded so fast in financial markets since the nemesis of March could unravel just as quickly in the reverse direction? What would set it off?

China and the dollar

All eyes are on the currency markets and further hints from China about the dollar peg and the future of its huge US bond holdings. Could there be some news to strengthen rather than weaken the ailing dollar that would set off a chain reaction in commodity markets priced in dollars that would overflow into equities?

Certainly in terms of fundamentals like earnings then equities have not been more overvalued since just before the dot-com crash when the global economy looked in much better shape. Investors who sat on their holdings then regretted it later.

Alternatively you might think that the government rescues of this year make the equity market a sure thing. Yet since when did relying on governments ever pay off for investors in the long-run?

It is a curious logic that sees continued low interest rates as a reason to be optimistic about the stock market when that also means interest rates are being kept low because the economy is too weak to handle the rates it needs to be kept inflation-free.

Equity prices should be much lower given the outlook for profits following the global financial crisis, and they will get there. And it is a historic fact that stock markets become undervalued in periods of inflation, not overvalued, if that is indeed where we are heading.


Written by Peter Cooper

November 15, 2009 at 9:02 am

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