The Relief Rally
In mid-February, in an article entitled ‘The Next Leg Down”, this column suggested that the equity markets were embarking on another selling wave which would carry them to new lows – i.e. to lower levels than those seen at the climax of the previous waves, in October and November. It further suggested that the levels reached in the then-imminent leg down would – unlike the series of lows made since October 2007 – stand for rather longer and provide a starting point for a serious and prolonged rally. Although this rally would still be a ‘bear-market rally’, representing only an intermission in the ongoing decline in the equity markets, it would nevertheless be longer-lasting and more substantial than the previous rallies, which had only lasted a few days or, at best a few weeks.
This entire scenario is based on technical analysis, which examines the charts and tries to ascertain likely developments going forward from past patterns and from data concerning trading volume, its division between rising shares and falling ones, as well as other statistical data generated by daily, weekly and monthly activity in the markets. Technical analysis has tended to be scorned by economists and is regarded as mumbo-jumbo by the general public. However, it has a much better track record as a predictive tool than its rival, fundamental analysis, which seeks to forecast the market as a whole on the basis of macro-economic developments and data, and individual stocks on the basis of the corporate data and developments reported by the company each stock represents.
Once again, technical analysis has proven its worth, because the forecast sketched in that article and summarised above has been largely realised – to date. Global equity markets did indeed record another sharp fall, which began in late January and climaxed in the first part of March. The Dow Jones Industrial Index fell to the mid-6000s and the S&P500 Index to the mid-600s. The main European and Japanese indices did as badly or, in many cases, even worse. Interestingly, the Tel Aviv market was one of a handful globally that, even at the low-point in early March, was still in positive territory compared to its level at the end of 2008.
More impressively, the markets have, over the last 2-3 weeks, recorded a powerful rise. Indeed, this rise has been so powerful that it has surprised even those analysts who were expecting an upswing. The strength of the rally to date indicates that significant forces are at work on the buy side, which strongly supports the idea that this rally ‘has legs’ and will run for months, rather than weeks – albeit not at the pace we have seen to date. But it is no longer absurd to speak of a rally phase in the markets which will continue through the spring and summer, perhaps even somewhat beyond.
That is the good news – and very good news it is, too, for all those who had not ‘capitulated’, whether voluntarily or because they were forced to, during the massacre of September-November and the further heavy drop of January-March. They are now recouping part of their losses and, more importantly in the global picture, the pressure on banks, insurance companies and pension funds is easing. Losses will decline and, for the first and second quarters, the norm in the financial sector may again become the reporting of profits. The entire financial system can breathe easier, thanks to which governments and households can also feel better.
Unfortunately, though, the same technical analysis – and there are a whole spectrum of approaches and methodologies under the general umbrella of ‘technical analysis’ – views this rally, long and strong as it may be, as no more than a ‘bear-market rally’. That means that the major bear market will resume at some point, whether that point is in the summer or (aptly-named) fall. The bottom recorded in March is not expected to be THE bottom of the major bear market that we are in. There is worse – according to some approaches, much worse – to come.
There is, of course, no guarantee that these predictions will be proven correct. It is also possible that Fed Governor Ben Bernanke and the rest of the American economic policy-making team, along with all Obama’s men, are correct in identifying late 2009 as the nadir of the overall recession, after which a recovery will begin. If so, further massive drops in equity markets are unlikely. But for the last three years, since before the official start of the financial crisis, the Establishment has been wrong and the non-mainstream analysts – especially the technicians amongst them – have been right. It would seem safer to ride the rally but make sure to exit the market during the summer, than hope that the policy-makers have finally tamed the raging bear.