Weekly outlook

Crisis? What crisis?

By Tom Stevenson, 14 January 2009

The markets reaction to bad news can be a key indicator that a bear market has come to an end Stock markets don’t need the business headlines to improve in order to start rising again. It is enough that the news stops getting worse. When this happens, investors can be reassured that all the bad news is priced into the market – even when there’s more gloom still to come. At this tipping point everyone who wants to get out of the market has done so. The next transaction sees a willing buyer persuading an existing holder to part with their stock – it’s a very different deal, although it looks the same, from a nervous seller persuading someone to take shares off their hands

"Market recovery does not always precede recovery in the economy but it usually does" Tom Stevenson

That is what happens around market lows. It is the exact reverse of what happens at the top of the market. At the top, the news does not necessarily stop being good, but it does stop getting better. The last person who wants to get into the market is already there. There is only one way to go.

This interplay between buyers and sellers is related to the economic cycle but it often does not coincide with it. This is why the stock market can pick itself up off the floor a good six months or so before there is any evidence that the economy itself is on the mend – and start falling while the sun is still shining out of a clear blue sky.

Recovery in the market does not always precede recovery in the economy but it usually does, and the start of a bear market invariably arrives well ahead of the economic pain itself.

Spotting the turn

With the benefit of hindsight, it is usually clear what has taken place. But how can you spot what is happening in real time so you can profit from it?

One of the best ways is to watch how the market responds to announcements because a clear indicator that the last seller has left the building is when the market fails to fall on bad news. A recovery in the market can only happen when it is able to shrug off disappointments.

There have been plenty of opportunities to test whether we have reached that happy moment in the past few weeks. Indeed back in November when the market rose nearly 3% on weak US unemployment figures, some investors dared to hope that “the” low, and not just “another” low, had been reached.

Economic data in the past few days, and the market’s reaction to them, suggests an element of wishful thinking in the rally that began in November. In the past week there’s been some terrible data on both sides of the Atlantic and in both cases the market has not taken it well.

Last Friday saw the announcement of a second consecutive month in which employment outside the US agricultural sector (so-called non-farm payrolls) fell by more than 500,000. The S&P fell by more than 2% on the day and by the same margin on Monday.

Over here, the worst quarterly survey ever from the British Chambers of Commerce saw the FTSE 100 fall by a similar percentage on Tuesday this week. The market in both the US and UK clearly still has the capacity to be shocked by the scale of the economic downturn.

 Patience required

It would be optimistic to think that the news is not continuing to get worse. In one issue of The Financial Times this week, the following headlines told a different story:

“Retailers have worst Christmas on record”, “Surveyors report slowest house sales for 30 years”, “Spending on adverts set to be reduced further” and “Economic conditions tumble to two-decade low” made for a grim cocktail of news.

Equity investors are caught between those who see an economy on its knees and those who see a stock market trading at attractive valuations not seen for many years or even decades. The gloom-mongers are supported by an army of sellers, still desperate to repair their battered balance sheets. Behind the optimists is a tidal wave of cash piled up in money market accounts and safe but over-priced government bonds.

At some point this year that titanic struggle will resolve itself. The last seller will wave good-bye to the market, stocks will shrug off yet another awful piece of economic news and a new bull market will be underway. The market’s anxious response to this week’s crop of statistics suggests we are not there just yet. Bear markets demand a great deal of patience.