The next leg down
The action in global equity markets this week was sickeningly familiar. Rarely has the golden rule of ‘buy the rumour, sell the fact’ been as consistently adhered to as during the course of the current crisis. Throughout 2008 and now into 2009, the Federal Reserve and the Treasury have unveiled a string of rescue operations, new programmes and plans of every sort – but always of increasing dollar size – to stop or reverse the deterioration underway in the markets and the economy. On virtually every occasion, the period of rumours and speculation preceding any given move has seen prices rise. And every time, either with the announcement itself or immediately thereafter, the markets have plunged anew.
This week was no exception. The much-hyped bailout plan for the banking system, as unveiled by Treasury Secretary Tim Geithner (on Tuesday evening Israel time, when we were all busy with more important things, like voter turnout and the exit polls), proved to be the dampest of damp squibs, leaving everyone feeling totally let down. The market began to crumble even before he stood up to speak – either from habit or thanks to leaks and good old inside information. The sharp fall registered on Tuesday saw the Dow Jones Industrial Average fall, once again, below the 8,000 level. However, whereas on the previous occasions this happened, in October, November and January, the index jumped straight back up the very next day, this time it went down and stayed down. Wednesday was a quiet day with a slight rise, but not enough to regain the round-number level. Thursday started with another lurch down, making it seem that this time the Dow is leaving the 8,000 level behind as it heads to new lows in the current bear market.
It was preceded in all this by its Japanese cousin, the Nikkei 225 Index, which has also been playing with the 8,000 level over recent months. The Nikkei fell through it again on Tuesday (Monday night in the US) and kept going lower in a holiday-interrupted trading week in Japan. Several analysts have remarked on the coincidental parallel of numbers between the two indices, and the much more serious and substantive ‘race to the bottom’ that has developed between them over the last year or more.
Nor is it just these two: in the US markets, the technicians are looking at other ’round number levels’ that have proven to be significant, as ‘resistance’ or ‘support’ levels going back for ten years or more. These include the 800 level on the S&P500 Index, the 1,500 level on the Nasdaq composite and the 3,000 level on the Dow Transportation Index. To ‘fundamental’ analysts, attaching importance to this or that number is silly and making investment decisions on that basis is like voodoo – but then fundamentalists believe in rational markets, so it’s no use listening to them. The technicians claim that their charts map people’s actions – at what level they started or stopped buying or selling. Since round numbers ‘speak’ to people, they affect their behaviour and therefore tend to matter.
In this case, the argument between the two schools is largely theoretical. The majority in both camps expected and continues to expect the equity markets to ‘make another leg down’. There is much more disagreement as to where this might stop: in terms of the Dow Industrials, any number between roughly 7,400 and 5,500 has its supporters. But there is a silver lining to the renewal of the market massacre. Both camps, but perhaps especially the technical people, expect that the next major low will hold for some time and will mark the point from which a significant rally can develop. Unlike the bear-market rallies of 2008 and early 2009, this one should – so they claim – go on for months, and carry the market anywhere between 50-100% higher, albeit from the coming low.
Since the markets around the globe have been so strongly synchronized in recent years (during both the boom and bust), there is every reason to expect this major rebound to be echoed around the world. It will surely cause many raised eyebrows, because economic and business conditions are set to worsen for many months to come. It will also likely raise great hopes that the markets are ‘predicting’ the coming end of the recession and the onset of the global recovery. That, however, may prove to be premature and, if so, it will create a very dangerous trap. But first let’s see this ‘major bottom’ and the ensuing ‘major rally’, and then we’ll worry about whether it’s a trap.