bull run or a bear market rally?

Published August 8, 2009
Albert Lam
Investment director
IPP Financial Advisers

THE global stock market has seen an incredible transformation over the past few months - from an Armageddon scenario to a super bull run that yielded a 40-80 per cent rally on most Asian bourses. Those who are invested have been handsomely rewarded, while those who are not adequately invested are hoping for a retracement that has yet to materialise. One common question among investors is: Have we missed the boat?

Many people expected a rebound from March's low but very few or none predicted the strength and length of this rebound. What caused the massive run-up after March 2009? I can think of four reasons:

1. There was a genuine sigh of relief that the financial system did not collapse, which restored investor confidence. However, just because the financial system did not break down, does not mean there are no problems within the system. I will use an analogy to describe what has happened. Mr Financial System was supposed to die from cancer but last-minute surgery got his heart pumping again. Everyone was happy that Mr Financial System did not die. However, Mr Financial System is only in cancer remission mode - there could be a relapse. His condition needs to be monitored carefully and he needs lots of long-term treatment and regular reviews before he can be pronounced well.

2. The concerted effort by governments worldwide to inject money into the financial system helped restore investor confidence, which resulted in risk aversion abating. Before long, chasing risk was back in form. We must go back to time-tested wisdom like proper asset allocation, diversification and regular portfolio reviews. Do not panic when others do, and do not be overly bullish just because others are jumping in big time.

3. Massive liquidity also played a big part in this rally. There was more than US$4 trillion in money market funds in the US alone at the start of this year. And since March, more than US$500 billion has flowed back into other higher-yielding assets. We see similar stories worldwide. In fact, many commentaries have called this a liquidity-driven rally.

4. The low interest rate environment means money in the bank is not a good alternative because the returns on deposits are not worth much. Therefore, investors have been encouraged to put their money to better use in the stock market. And rightfully so, if I may say.

However, fundamental economic data does not support such a massive rebound. The foundation of any economy is consumption - cycle feeds on demand.

Let's look at the US, which represents roughly 20 per cent of global GDP. The unemployment rate is heading towards the 10 per cent and could go beyond that. To add more pain, banks have reined in the availability of credit, which is a temporary lifeline to some. Property prices are still deteriorating year on year and the option to borrow from this asset class is out of the question. In these circumstances, we conclude that the US economy is still extremely weak. Unfortunately, Europe is in a similar condition. And Eastern Europe is in even worse shape.

Let's look back and recall what sparked the 2008-2009 Great Recession? It started with a financial crisis, which culminated in an economic crisis.

What we experienced last year is a serious crisis that almost broke the entire financial system. Liquidity was quickly soaked up and lending came to standstill. Banks were forced to either sell investments to meet demand or face collapse. This is what we saw recently when lending came to a standstill. No one trusted the banks with their deposits, prompting several governments to guarantee such deposits.

This evolved into an economic crisis, with most countries now in recession. They suffered a sudden downturn brought on by a financial crisis, with falling GDP, negative growth and high unemployment.

Can we have a genuine bull run under such conditions? It is not uncommon for bear market rallies to reach 50-70 per cent. The Dow Jones Index hit a high of 11,750 points at the peak of the technology bubble in January 2000 and collapsed to 8,062 in September 2001. It then staged an incredible bear market rally for the next six months to a high of 10,673 before crashing to a low of 7,197 six months later. The Straits Times Index went through a similar ride in the 1998 currency crisis. It fell from a high of 2,145 in January 1997 to a low of 1,040 in January 1998. It then rallied to a high of 1,553 in March 1998 and subsequently bottomed at 800 in September 1998.

Throughout the economic and financial crises of the past few decades, bear market rallies have come across as fierce and over-optimistic.

I am not saying this is definitely a bear market rally. However, I would rather be cautious than overly bullish. The foundation is still weak, although we have seen much improvement in sentiment, corporate results and some improvement in economic numbers. The International Monetary Fund has forecast a US$4 trillion loss from the credit/financial crisis, and the banks have written off about half of that so far. What will happen to the balance? All types of loans, led by sub-prime, are seeing a surge in delinquency.

Whether this is a bull run or a bear market rally, we must go back to time-tested wisdom like proper asset allocation, diversification and regular portfolio reviews. There are investment products out there that are not correlated with the stock market. There are regions and sectors that are still doing well despite the downturn. Do not panic when others do, and do not be overly bullish just because others are jumping in big time.