It may take a while yet before the general commentariat is willing to accept that dynamics for global equities have now irrevocably changed. However, on my observation, today's equity markets are increasingly showcasing the main characteristics of a bear market.
Does this mean we are guaranteed staring at losses of -20% and more?
No. But we might.
"If it Looks like a Bear and Trades Like a Bear, Stop Trading it Like a Bull."
(Quote above from Morgan Stanley strategists in a recent market update)
What is not well understood by many a market participant is that downturns, trend reversals (or call it whatever you want) like the one we are experiencing right now are not an outcome that is already set in stone. It is a process consisting of multiple stages, and the ultimate outcome will be decided by what comes next, and how we as a global community respond to it.
Take the opening months of 2016, for example. Declining global growth, falling oil prices and a Federal Reserve intent on continuing tightening created a poisonous cocktail that was similarly pushing equities into a downward spiral. That only stopped from the moment the Fed gave in.
This time around the Fed pausing its tightening might act as the necessary circuit breaker, as would be a genuine agreement between the Trump administration and China, or a much stronger economic background; but so far none of these scenarios have emerged, and financial markets clearly are not going to sit around, waiting for Godot.
In the meantime, and I am not the only one making this observation, trading activity inside the Australian share market very much resembles that of a genuine bear market. Bad news is being punished without recourse. Good news might trigger a share price rally, but that subsequently becomes a source for taking profits and raising more cash. No news can mean anything, but most likely the stock is being sold off on flimsy correlations and spurious projections.
On some days, nothing really matters. If your stock is listed, and widely owned, it will be sold, simply because other shares are too. No room for exceptions.
All of a sudden, risk is everywhere; better not to take any chances.
Good news no longer rewarded
One recent example of how market dynamics, and investors' attitude, has changed is REA Group ((REA)). Prior to the release of its quarterly trading update, which proved significantly better than what worried investors had been expecting given the downturn in the local housing market, the share price was trading in the low $70s.
Following the release of the quarterly update, REA Group shares jumped as high as $80.50 (and even higher intra-day) but they have subsequently retreated back to the low $70s again. Stockbroking analysts did respond positively to the better-than-expected operational performance, but nobody cares. Clearly, investors prefer safe profits and cash. Besides: this housing downturn is going to last a while yet. REA Group might not be able to stay immune.
And so the narrative goes.
What happened to REA Group equally happened to a2 Milk ((A2M)), Altium ((ALU)), Appen ((APX)), Brickworks ((BKW)), Elders ((ELD)), Xero ((XRO)), and others. Good news is no longer being rewarded and if it is, it won't stick.
Earnings growth recession a possibility
One of the major worries for investors globally is that it may yet be a little early to call for an economic recession soon, but it appears growth in corporate profits is not holding up, which means consensus forecasts will have to come down, and this means share prices need to reset at a lower level, irrespective of any movement in bond markets.
Australian companies are currently making plenty of contributions in support of this thesis. Witness the negative announcements from Medibank Private ((MPL)), Fletcher Building ((FBU)), Viva Energy ((VEA)) and Myer ((MYR)), to name but a few from recent days.
Earnings estimates for ASX-listed companies are currently under negative pressure, and they are trending south as more and more triggers are being provided by companies including Pact Group ((PGH)), Aveo Holdings ((AOG)), Lendlease ((LLC)), James Hardie ((JHX)), and numerous others.
There may not be an economic recession on the horizon, but an earnings growth recession is definitely a real possibility. Further developments need to be watched closely.
Buy the dips? Not so fast
In terms of general market momentum, analysts at Morgan Stanley report for the first time since the year 2002, buying the dips is no longer working in 2018. My first thought after reading this was: so it worked in 2008 then? Apparently it did. But not so this year. The team of Quantitative Derivatives Strategies is now recommending investors/traders stop acting like it's still a bull market; time to sell the rallies instead.
We can all be certain this is the new momentum trade already adopted by automated trading strategies.
Equally worth pointing out is most equity indices, including the S&P500 and Nasdaq, are now trading below the 200 day moving average; and that average has started trending south. History suggests under such circumstances the highest virtue for any investor is: having cash at hand plus patience.
Morgan Stanley research shows when "Buying the Dip" strategies no longer work, equities are either in the middle of a bear market, or about to commence one. Years prior to 2018 when "Buying the Dip" stopped working include 2002, 2000, 1990, and 1982.
Double top: The harbinger of doom
Another observation that can be seen as an ominous signal is most equity markets the world around are showing a double peak pattern on price charts this year. Again, history suggests such a classic "double top" formation can be a harbinger of a much tougher environment ahead.
Consider, for example, the year 2007 equally shows two share market peaks, as does the year 2000 as well as, further into the past, the years 1990, 1980, and 1960.
Not all bears are created equal
The first thing that comes to mind when someone mentions "bear market" are the savage sell-offs that occurred in 2008-March 2009 and post the Nasdaq meltdown of 2000 with share markets losing more than half of their value before a bottom was ultimately found, not mentioning the fact that individual share prices can incur a lot more damage than the market average during such testing times.
But a bear market doesn't need to be of such grandeur. Since 2009, equities have experienced two extended periods that offered lots of pain and very little gain outside of steady dividends and a small selection of exceptions. First, between April 2010 and June 2012, the Australian share market went up and down a lot, but ultimately lost -19% over more than two years. Secondly, after peaking in May 2015 equities kept on losing momentum until a capitulation sell-off in early 2016 took the market down -21% from nine months prior.
The positive news is that in both cases there was no economic recession on the horizon, and thus market losses never went the way of 2008-2009 or 2000-2003, but investors had still been better off by not trying to be a hero, instead opting for plenty of cash and timing their re-allocations with lots of patience.
Within this context I note it is quite remarkable strategists at Morgan Stanley, who have been predicting the scenario for equity markets in 2018 quite accurately, are suggesting investors could be facing something similarly relatively benign in the greater scheme of things, assuming consensus forecasts will be coming down soon, thus becoming more aligned with what is happening with corporate profits sometime during Q1 next year.
On this assumption, and assuming no further negative developments elsewhere, Morgan Stanley is taking the view US equities might be -90% through their downward re-valuation ("de-rating"), which could translate into higher volatility for longer, but maybe without a lot of additional downside from the index lows posted in October.
Equity markets, of course, still have to deal with slowing global growth, retreating liquidity, and lots of geopolitical threats and uncertainties (the bond market has been relegated to the background, for now).
I was of the intention to share some of my observations and portfolio experiences from the past two months, but I'll leave this for next week, maybe. Suffice to say: cash on the sidelines has been the only asset allocation that has made a genuine difference over the past eight weeks or so.
That too is one big message for investors. Make sure you sleep well at night.
Is a Santa Rally in the works?
Thus far, November has delivered nothing but disappointment for investors hoping for a swift recovery post an unusually savage October sell-off. The local share market is down -3.1% with eight trading sessions left before December begins. Remember, October saw the index down -6.1%, but well off its lows, and September also proved a market negative: -1.77%.
The good news here is share markets are heavily oversold and historically this has always triggered a rally; it might just be sufficient that downward pressure abates, if only for a while. This, of course, keeps hopes alive we might see a broad rally into year-end, in particular with shares looking "cheap" after two months of selling pressure.
Further feeding into investor optimism is the seasonal pattern for Australian bank shares to first weaken post financial results while paying out dividends, and then put in a recovery move upwards into the new calendar year. Two weeks ago (see also below) I wrote the historical pattern for these sizable share market sell-offs is a rally first, and a likely re-test of the low point next.
It may well be that the local share market is testing the October low this week, creating the platform for this year's Santa rally take-off.
That remains the missing ingredient in this bear market; violent rallies to the upside.
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Many financial commentators try to be clever by talking up bull markets in the Australian market selectively using short snapshots of market movements. Not only is this annoying, it is misleading and quite dishonest. The Australian share market has been permanently in a bear market ever since the GFC unlike almost every other economy. Our market can only shift into a bull market territory when the ASX exceeds the all time peak of some 6,800 in late 2007.
Hi Mark, not exactly sure if I am included in your targeted critique (I think I don't deserve to be), but irrespective I respectfully disagree with your assessment below about the bull market. The correct way to look at the share market is by including dividends paid out and on this measure the share market passed its pre-GFC peak many moons ago. In addition, I have been arguing for years now that these broad indices no longer represent "the market" in the same manner as they once did. There may not have been a bull market in banks and large parts of the old economy segments of the ASX, there has been nothing less than a raging bull market in other parts of the market, and I have written extensively about this. It's merely a case of does one actually want to see it, and adjust to the changing environment, or not?