Be­ware the bear trap

Dow’s ‘good­bye kiss’ pre­vi­ously of­ten fore­cast fur­ther price drops

Finweek English Edition - - Creating Wealth - LU­CAS DE LANGE

HOPES THAT THE RALLY by the Dow Jones in­dus­trial av­er­age since early last month was the start of a re­cov­ery on share mar­kets have be­gun to fade af­ter the re­bound was halted ex­actly on the neck­line of the neg­a­tive head-and-shoul­ders for­ma­tion. In tech­ni­cal cir­cles, that’s some­times re­ferred to as a “good­bye kiss” pre­ced­ing fur­ther falls.

Ex­pe­ri­enced mar­ket play­ers no­ticed that, as was in­di­cated by an anal­y­sis by David Rosen­berg at Mer­rill Lynch. That showed it’s danger­ous for in­vestors to be­come ex­cited about the re­cent strong ral­lies of 332 and 302 points in the in­dex within one week. The rea­son for that is that never in the his­tory of Wall Street has there been a rally of more than 300 points in one day dur­ing a bull mar­ket. That only hap­pens in bear mar­kets, partly be­cause spec­u­la­tors try to close short po­si­tions while there aren’t many buy­ers.

It’s only dur­ing bear mar­kets that 300plus points oc­cur and, in the past, that has of­ten pre­ceded a so-called bear trap. A bear trap oc­curs when the mar­ket sud­denly starts looking strong, pos­i­tive re­ports ap­pear in the me­dia and some com­men­ta­tors spec­u­late that things are go­ing to im­prove. Buy­ers tend to com­pare prices with the high lev­els achieved dur­ing the bull phase (es­pe­cially at the time when the head for­ma­tion occurred) and then buy. That usu­ally re­sults in losses.

An ex­am­ple was dur­ing the pre­vi­ous bear mar­ket, when a rally of nearly 500 points in the Dow occurred on 16 March 2000. In­ter­na­tional hopes surged. How­ever, shortly af­ter – on 14 April 2000 – the Dow tum­bled by no less than 618 points, hurt­ing many in­vestors who’d landed in the trap.

An im­por­tant fac­tor that must be kept in mind when a rally oc­curs is whether it’s tak­ing place due to ex­pec­ta­tions that the econ­omy and prof­its are go­ing to im­prove. If a rally oc­curs in the midst of pes­simistic profit fore­casts, it’s vir­tu­ally cer­tain it will only be tem­po­rary.

Only when a rally is based on ex­pec­ta­tions of higher com­pany earn­ings should it be taken se­ri­ously as a sign the bear mar­ket is draw­ing to a close. On most mar­kets that’s not cur­rently the case. In fact, an in­creas­ing num­ber of com­pa­nies are plan­ning for harder times. Prof­its are un­der pres­sure, as can also be seen in SA, for ex­am­ple, at banks and re­tail­ers.

The one as­pect where the JSE dif­fers from the Dow is in re­spect of re­sources shares. For ex­am­ple, in con­trast to the mar­ket as a whole, the graph of BHP Bil­li­ton is still in a bull mar­ket. Op­ti­mists be­lieve it’s cur­rently un­der­go­ing a bull mar­ket cor­rec­tion and only when sup­port lev­els around R165 to R185 give way does there have to be any con­cern about a real bear mar­ket.

Re­marks by BHP Bil­li­ton CEO Mar­ius Klop­pers af­ter it was an­nounced that the group’s profit in the sec­ond half of its fi­nan­cial year had in­creased by 30% – and the fi­nal div­i­dend had been boosted by 52% – make clear why there’s hope that this huge group will con­tinue ben­e­fit­ing from the so-called com­mod­ity su­per cy­cle.

Klop­pers be­lieves that de­spite price volatil­ity due to the eco­nomic down­turn , the de­mand for com­modi­ties, es­pe­cially from China, will re­main re­silient be­cause of a strong do­mes­tic de­mand. That will sup­port prices.

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