Is This Rally For Real?

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By

Prabhat Sakya

Published in Investing on 2 February 2012

Stock markets around the world are rising. Why?

Cast your mind back to the beginning of December. The eurozone seemed to be going to hell in a hand basket, with Greece in dire trouble, and Spanish and Italian bond yields climbing to an unsustainable level. Europe was slumping towards recession and the US was slowing down. Even in emerging markets, there was fear of a 'hard landing' in China.

There were the usual end-of-year predictions from the pundits, and I don't think I have known a time when there has been more doom and gloom. 2011 had been a torrid year for investors, and many were expecting more of the same for 2012. Few people dared predict any kind of stock market rise, and many were recommending that investors stay on the sidelines with their cash.

The best start for 18 years

So far, these bearish pundits have been resoundingly proved wrong. Stock markets around the world rallied in December, and the rally has continued into January. We have had a great start to 2012 -- in fact, shares around the world have been off to the best start in 18 years.

In January alone, the MSCI World Index rose 5.8%. Interestingly, there seems to have been a move from the defensives that did so well late last year to cyclicals. Sectors that had previously really suffered, such as banks and miners, were now forging ahead. And small companies, which had also taken a big hit, were recovering.

But we know that shares tend to do better than average in December and January -- is this just another example of the Santa rally and the January effect, with shares then falling back again? Or is this rally for real?

I think it's for real

My view is that this is for real. In the tug of war between bears and bulls, up to now the bears had been winning. But in the past month we have had a flurry of good news.

Firstly, in Europe the European Central Bank's offering of €489 billion of cheap money, known as the Long-Term Refinancing Operation (LTRO), to the region's banks has acted as a kind of back-door quantitative easing, pushing down bond yields and substantially easing the pressure on the eurozone.

And there is more cheap money on its way, with the second round of the LTRO coming up on 29 February, and this time it has been estimated that as much as €1 trillion could be taken up by banks.

The news seems to be positive even in Greece, with a deal to restructure the country's debt nearing.

Plus there have been some really strong numbers in the latest company results, especially stateside. Apple (NASDAQ: AAPL.US) had another amazing quarter, and businesses like McDonalds (NYSE: MCD.US), Caterpillar (NYSE: CAT.US) and BSkyB (LSE: BSY) also impressed.

What's more, the news from China has been good, with signs that the economy -- in particular, the property market -- is going through a gradual slowdown rather than a collapse. The much-heralded soft landing seems, finally, to be happening.

And there has also been an improvement in purchasing managers' indices around the globe; this key measure of business confidence is providing further evidence that things might not be so bad after all.

Money waiting to be invested

All this adds up to a rally in world stock markets. When will it end? There is bound to be a pull-back at some point, but who knows when? All I can say at the moment is that momentum is continuing to drive shares higher, and more and more investors are being tempted to dip their toes back in the water.

Let's not forget, there is a veritable wall of money waiting to be invested. After all, bank interest rates are near zero, bond yields in countries such as the US and the UK are at record lows, and property prices around the world continue to slump.

Successive rounds of quantitative easing are devaluing currencies, and the gold rally can't go on forever. Investing in the stock market, and especially in high-yielding blue chips, is increasingly looking like the best bet.

It seems that, finally, investors are cottoning on to this fact.

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> Prabhat owns shares in BSkyB.

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Comments

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compound200 02 Feb 2012 , 1:38pm

i dont understand how EU is borrowing money to give bailouts to its own members

also why hasnt the euro currency bombed


its easier understanding the universe

jeff700 02 Feb 2012 , 3:55pm

I don't get the rush to own stocks at these prices, unless you're short term trading. The yield of the FTSE100 is far too low, more like a bull market top than a bear market bottom, very strange!

And shares are in a bear market, gold is in a bull market. Until the price of gold and the Dow Jones index converge to around the same number, as they've done in the past, it's a waste of time owning stocks but every incentive to own gold.

salmo365 02 Feb 2012 , 4:03pm

The EU isn't borrowing money, The ECB is creating out of thin air money to give in loans to banks at zero interest rates and they in turn are taking the money and buting government securities paying 6% plus.

Easy money for the banks. The Euro hasn't collapsed because the money isn't leaving the euro zone, if the european banks started using this ECB money to buy foreign assets then you'd see the Euro move.

salmo365 02 Feb 2012 , 4:07pm

And the FTSE is trading at a P/E of around 10.5. I think you'll find that is quite low by historical averages. In 2010 it was closer to 17.

salmo365 02 Feb 2012 , 4:09pm

The current dividend yield is 3.7% which is also historically very high.

jf2007 02 Feb 2012 , 4:26pm

several US companies such as Google and Amazon have delivered disappointing results which have been shrugged off by the general markets. Not to mention Exxon and Tesco. I wouldn't be surprised if the FTSE was either 6000 or 5100 in two weeks time

jeff700 02 Feb 2012 , 4:39pm

Salmo, you could get a higher yield than 3.7 in most of the 1970's all of the 1980's and a lot of the 1990s. The last bull market, of which started around 1981, the Allshare was yielding close to 7%. A yield of 3.7 is just pathetic.

Again with all the problems of the world and Japan style lost decades probably to come a PE of 10 is again incredibly high. I'm out!

compound200 02 Feb 2012 , 4:42pm

thx

salmo

SimpleEconomics 02 Feb 2012 , 9:30pm

A pe of 10 is not high check your facts. Also you need to compare dividend yield to base rate. No point in getting a yield of 5% if the base rate is 10%

vinchainsaw 02 Feb 2012 , 11:15pm

Bear market rally.

snoekie 03 Feb 2012 , 4:50pm

Salmo, not creating money, but fraudulent entries to show that there is money in the account, which is a fiction and which if a business did they would have the boys in blue around quicker than two shakes of a ducks tail if done by a plc, feeling the directors collars.

Just where did this 'money' come from? Answer, it didn't because there was nothing in the kitty, lead bars with a super thin gilt layer.

I am sitting on my hands and thoroughly bemused.

Drunsfleet 03 Feb 2012 , 6:48pm

Yes if the FTSE 100 continues this rally it may reach 6000 - a rally back to where it was 12 months ago! If it can push on to 6500 we will back to where we were 5 years ago!!

The returns on the FTSE 100 as an Index are negative for the last 12 months - and seeing as many of these companies are not just British but global in nature reflects perhaps a recessionary/deflationary expectation toward the global economy.

Things can only get better. Unless they get worse!

drfuzz 08 Feb 2012 , 1:18pm

Is the FTSE really historically cheap?

I've been reading a rather long paper which was mentioned in a fool artice (can't remember which, may have been one of Prabhat's) which looks at long term asset returns. 100 pages, but well worth it: http://www.etf.db.com/UK/pdf/EN/research/researchfixedincome_2010_09_13.pdf

Anyhow, one of the many messages from there is that the last 20-30 years are a bit of a blip, so comparing the P/E of the market now to a P/E during this period isn't necessarily a good comparison. It implies the market is about fairly valued at the mo (and indeed figures from Graham's Intelligent Investor coroborrate this).

I personally think we will see a collapse at some point during the year of the first half of next year. My initial expectation was March, when Greece will default, orderly or otherwise bringig things to a head. However, the fact 25 european countries have managed to come to a budget rules agreement have caused some optimism, so March looks less likely IMO. That said, the conditions of this agreement, which enters in January 2014, are in my opinion still not realistic for a lot of countries. I think that this will become apparent later in the year or at the beginning of next year as deficits fail to fall and as a result we will see another collapse (maybe the last in this particular episode). I simply cannot see how Ireland, Portugal, Greece and possibly even spain are going to meet the 3% criteria when they're currently running deficits of 6-11% despite having already made significant cuts. You have to wonder how much more can be cut in some cases.

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