If this rally is the real McCoy, most people will miss out

If this rally is the real McCoy, most people will miss out
Winter on the markets could finally be ending, but it will take time for investors to shed their bearskins.

By Tom Stevenson
Last Updated: 10:25AM GMT 26 Mar 2009

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Perhaps it was all that gloriously unseasonal weather last week. It's hard to maintain a bearish scowl in the face of catkins, daffodils and blue skies. Whatever the reason, investors have had a spring in their step on both sides of the Atlantic. The obvious question is whether the 22pc two-week gain on Wall Street, or the rather more subdued 13pc three-week rise over here, is just another bear market rally or the real McCoy.

The US reversal has certainly been spectacular, especially the Geithner-inspired 7pc surge in the S&P 500 on Monday. That was the fifth biggest one day rise and the best performance in a single session since last autumn's gyrations. Over here things don't look quite so special – we've been here several times already during this bear market.

Since the FTSE 100 peaked in June 2007, there have been four rallies of 10pc or more. The first was the phony war between August and October 2007 when we kidded ourselves that the problem was "over there" and could be contained in the financial and property sectors. Shares rose by 15pc.

Next was the 18pc Bear Stearns relief rally between March and May last year. Phew, we thought, that gets all the bad news out of the way. There was another 10pc rise in the holiday lull before the collapse of Lehman Brothers ensured that all bets were off in September and October.
Finally the year ended with a 15pc act of collective self-delusion when we thought the "real economy" might escape the worst effects of the credit crunch. Even as investors were crossing their fingers, the economy was in fact falling off a cliff.

So why should the latest bounce be any different? The rise so far is bang in line with the other rallies that came to nought. Why shouldn't it also peter out when investors find something new to worry about?

The first reason is that, with every downward lurch, the valuation argument becomes ever more compelling. Yes, shares have been cheaper but on increasingly few occasions. Buying shares when they have been available at the current multiple of earnings has in the past given investors a better than evens chance of achieving a 10pc a year return for a decade or more.

So even if this doesn't turn out to be the actual bottom of the market, on any sensible timescale for buying shares any further short-term losses are likely to be quickly clawed back. The more people who realise that this is the case, the more likely it is that this will indeed be the bottom.

The second reason to think the low point is near is the sheer length and depth of the bear market. The dot.com crash was longer but we've already matched the scale of drop. Only the 1970s and 1930s come close in size and duration.

Third, the market is holding up in the face of bad news, the best sign of all that the gloom and doom is already in the price. It is hard to imagine the market shrugging off Mervyn King's comments about the dire state of the public finances six months ago.

Finally, there are some tentative signs that the economy, if not exactly improving, is deteriorating less quickly than it was. Bear markets do not end when things get better but when they stop getting worse.

Signs to watch out for are things like the copper price – up by a third so far this year – and the Baltic Dry Freight index, which has risen sharply. Another straw in the wind is the very low level of inventories companies are holding. The smallest uptick in demand will immediately feed through into higher industrial production, so economic expectations might even be exceeded rather than endlessly disappointed later this year.

Another positive to note about the jump in share prices in March was the breadth of the rally. The ratio of risers to fallers exploded in this month's rally, a classic signal that we have seen a real low rather than what the traders call a "dead cat bounce".

Of course, no one knows whether March 2009 will mark the bottom or not, but if it proves to be the low point one thing is certain: most people will miss it. Data from the US shows that the ratio of cash held in money market funds compared to mutual fund assets peaked more or less as the market hit rock bottom in 2002. The stock market had risen by 30pc over the subsequent 15-month period before cash levels had returned to average so most people got back into the market way too late.

That wouldn't matter if bull markets were steady affairs adding value smoothly from trough to new peak. But they are not. It has been calculated that more than a quarter of the total return from all the bull markets since 1930 came within the first six months of the bottom of the market being reached. A third came within nine months.

One of these warm spells will really mark the end of winter. How long will you keep your coat on?

Tom Stevenson writes on investment for Fidelity International. The views expressed are his own.

http://www.telegraph.co.uk/finance/comment/tom-stevenson/5050205/If-this-rally-is-the-real-McCoy-most-people-will-miss-out.html