Reuters: Bear-market rally not fooling anyone

Swift, sudden and destined to fizzle out, stock market bear rallies can offer investors a glimmer of optimism when the trend appears to be a one-way street south.

Most major stock indexes have rallied fairly sharply in the past couple of weeks. In Europe, the DJ Stoxx 600 index of leading European shares has risen by nearly 8 per cent since hitting a 2¼ year low in late March.

Multi-billion dollar injections of cash into money markets by some of the top central banks, coupled with investment banks doing their best to scrub their books clean of assets tainted by the US subprime lending crisis, have helped prop up markets.

The question is whether this rally is sustainable. Technical analysts say that, at best, equity markets are in a holding pattern as they attempt to stabilise after months of decline and, at worst, this is the calm before an inevitable storm.

"We're in a bear market whether we like it or not," said Tom Hougaard, chief market strategist at City Index.

"I can easily see that we could be somewhat lulled into a false sense of security, that the market will bounce from here, but we're consolidating in a downtrend, not an uptrend."

The European market is 276 days into the downward trend and has fallen 21 per cent from last July's 6½ year high.

At the same point in the 2000 bear market, the Stoxx 600 had fallen by 8.8 per cent but was only a quarter of the way through a 157-week bear cycle that stripped 60 per cent off the index from its record high on March 7, 2000.

LONG GRIND LOWER

And analysts believe the journey to the bottom of this bear market could be a long slog.

Nicole Elliott, a technical analyst with Mizuho Securities, said a lot of the uncertainty was tied to interbank markets, where rates have remained stubbornly high as banks are wary of lending to each other, despite cash injections by central banks.

"(The recent bounce) has done nothing to change my long-term outlook, which is bearish, and nothing to improve the current conditions, which have essentially been brought about by the credit crunch," Elliott said.

A bear market is commonly defined as at least a 20-per cent fall from a cycle peak. There is no single instrument to differentiate a bear-market rally from the start of a bull run. But a good way to start is by using Fibonnaci retracement ratios -- created by a trendline between two points on a chart.

A bear-market rally is a rise in a falling market that does not breach the 61.8 per cent retracement level -- no European market has come close to that point.

For the DJ Stoxx 600, that level is around 359.50, about 16 per cent above its standing. For Britain's FTSE 100, the level is around 6,211.1, or 5 per cent above its current value.

BLOT ON THE LANDSCAPE

Since the Federal Reserve's emergency 75-basis point cut to US rates in late January, European shares have made several attempts to rally and, typically for a bear market, each attempt has resulted in successively lower peaks and lower troughs.

Another major blot on the European technical picture is the contraction in the spread, or difference, between values on the FTSE 100 and Germany's blue-chip DAX.

Despite some of the FTSE's biggest members being so-called cyclicals, such as banks, oil and mining stocks, the index often acts as a defensive port of call for investors in a downturn.

The DAX, meanwhile, is made up of only 30 stocks, the bulk of which are banks, automobiles and macroeconomically sensitive transport and logistics shares.

At the height of the 2003-2007 bull run, the gap between the two indexes was 1,590 points. This has more than halved to about 690 as the more-volatile DAX has underperformed most western European peers.

"A really reliable indicator is when the DAX is much weaker than the FTSE ... there is no one indicator that will be the be-all and end-all but this one is about as good as it gets," said City Index's Hougaard.

"We are at a crossroads and ... if we go much lower, even by another 10 per cent, I really do think we'll not just be heading into a normal bear market but a fully-fledged recession."

Not everyone is so pessimistic. Gerry Celaya, a technical analyst at Redtower Research, believes current consolidation in the European equity market is likely to form a stable base from which it can rally at some point this year, but he does not rule out another downward move.

"I can see why everyone is looking at this as some sort of bear-market rally, which should peter out or which has petered out, and then see a resumption lower," Celaya said. "The problem we see with that is where does that resumption lower go?

"The most likely scenario is we'll see stock markets tread water from now to the summer, which is really frustrating but is more or less the scenario that unfolds."

Reuters | Tuesday, 15 April 2008

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