What an amazing couple of weeks. Just when it looked as if a new downtrend had become established, the market reversed direction and went on to carve out some of the most aggressive runs we’ve seen in a long time. In the US the Dow Jones has rallied more than 12% over the past 14 sessions, while in Australia the All Ordinaries has jumped 13% after rising 13 out of the past 14 sessions. (That’s the 3rd best 14 day streak for the All Ords over the past decade!) Both markets are at near nine month highs, having rallied almost 40% since hitting a bear market low in March.
The reason of course for this most recent push has been a solid US reporting season, or to be more accurate, a better than expected reporting season. In fact around 75% of the S&P500 revealed results that were above the consensus forecast. That is not to say that most results were good, indeed many showed a substantial drop in profitability, but if you are expecting an absolute disaster it doesn’t take much to impress.
The important thing to note is that what we have seen recently is a result of a significant shift in expectations and sentiment. In early 2009 the outlook was especially uncertain and serious doubts over the future of the major industrialised economies pervaded the market. Since then, although the outlook remains far from attractive, expectations have improved markedly. Stocks were previously being valued within the context of economic armageddon, but recent “green shoots” have allowed for more optimism.
Given this fundamental shift in perceptions, and the justification that this earnings season has provided, these recent gains are understandable. But then again, it’s never that difficult to rationalise past events. The real question is: where to from here? For a fundamentalist such as myself, sustained and significant gains from this point will require more justification in terms of positive economic and corporate data – and that is far from certain.
I am not arguing that things won’t continue to improve, but rather that the pace of market recovery will almost certainly slow. A 40% gain in 4 months is a rare thing, and it would be naive to expect this kind of momentum to continue unabated. Share prices are inextricably linked to company performance, which in turn are related to the economic environment. So if you expect to see another 40% gain in the next 4 months you are essentially betting on a dramatic and sudden improvement in the economy. I regard this as unlikely.
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