A Shot Across the Bows
Equity markets across the developed world reached the finishing line of 2013 in fine fettle, having notched up one of their strongest years this century (in some cases the best since the mid-1990s). The previews of the upcoming year were almost universally bullish – analysts who expected less than double-digit rises for 2014 were decidedly in the pessimistic camp. Meanwhile, many prominent bears had given up during the bull run of 2013 and the few that remained preferred to keep a low profile.
However, the early weeks of the current year have seen share prices fall almost everywhere. Some important indices made their highs on the closing days of 2013, whilst others kept going through the first half of January. But the charts of almost every index show January 22/23 as a turning point. Markets that had been soft before that saw an abrupt lurch lower, whilst those that had held up until then crumbled.
The wave of declines in the fortnight from the third week of January to the first week of February was strong enough to shave 5-8% off most indices and more off some. But it has not been sufficient to shake the underlying confidence of that herd. On the contrary, many analysts have presented the recent round of falls as a phenomenon that is both inevitable – no market moves in a straight line – and desirable, since it provided an opportunity to regroup, prior to pressing on to further gains. Indeed, the bullish view is that “corrections” are to be welcomed, since they present an opportunity to buy more stocks at better prices.
This logic is very attractive, not least because it is tried and tested. There haven’t been many corrections – usually defined as falls of 5-10% — over the last two years, but whatever dips have taken place have turned out to have been just that: short-lived dips and limited corrections, within the framework of an ongoing uptrend. Why should the current fall be any different?
Arrayed against this mainstream flood of bullishness are those bears who have been emboldened by the drop to emerge from their lairs. They are, as usual, full of doom and gloom (search out, for example, various interviews with Marc Faber, publisher of the “Boom, Doom and Gloom report”). The more mild-mannered bears are looking for a major correction, in the order of at least 10-20%, whilst more aggressive ones expect a bona fide ‘bear market’, usually defined as one in which the index falls in excess of 20%. Serious, heavy-duty bears will not be satisfied with a common-or-garden bear market, rather they await a crash of significant proportions – usually understood to mean upwards of 40% from high to low.
One of the most important pieces of evidence that the bears cite to support their view is the degree of complacency that characterized the markets prior to the current pullback. Almost every indicator of sentiment, relating to individual investors, professional advisers, fund managers and other defined groups in the markets, ended 2013 at levels of optimism/ bullishness rarely if ever seen before. That, in itself, strongly suggested that the markets were ready for a fall. On the other hand, the excessive optimism could dissipate gradually and over time, in a choppy, ‘sideways’ trend in prices, without there being a major decline.
Interestingly, most technical analysts – including those at some of the biggest investment banks – have been warning for weeks, if not months, that their indicators showed the markets to be severely overstretched. They still think so and, if anything, are impressed with the speed and severity of the decline so far, to the point that they expect more downside – in some cases, much more.
Where a big change in attitude is apparent is among the macro-economic fundamental analysts. They are concerned that the global economy is slowing instead of picking up steam. They are especially concerned about the emerging markets, many of which have been severely battered by capital outflows in response to the change of direction of American monetary policy, from massive expansion to very gradual tightening.
But they are especially worried about the situation in China, where the prolonged and huge investment boom is showing signs of turning into what might become a mega-bust. Only when you realize just how much money the Chinese government pumped into its economy over recent years – enough to make the Americans look stingy by comparison – does the scale of this potential threat of bankruptcies and recession in China become clear.
To these rapidly-accumulating foreign woes has been added a spate of bad data relating to the American economy. True, some of this is due to the appalling weather much of the US has suffered, but that can only excuse or explain some of the weakness. The weather is, so to speak, just the ice on what seems to be a stale cake.
In short, all it needs for the sell-off to extend much further in time and extent is for the Fed to stick to the ‘taper’ and for the Chinese weakness to continue. Because the basic, bitter truth is that despite printing trillions of dollars and yuan, the Americans and Chinese have fixed none of the main problems that caused the global economic crisis of 2008 – in fact, some of the imbalances are even worse now than they were then.