Running with the bulls

This week we learnt that Australia has (so far) narrowly avoided a recession; a technical recession that is. However there is another technical definition that has so far largely escaped popular attention…

It might not feel like it, but we are technically in a bull market. Of course corporate profits and capital expenditure have plummeted, the economy is suffering significant pressures and the Australian share market remains a hefty 40% below its 2007 high. So how on Earth can we be said to be in a bull market?

A bull market is characterized by a broad improvement in share prices, and is usually technically defined as a 20% improvement in the primary benchmark index. Since early March this year the Australian market, as measured by the All Ordinaries Index, has gained over 26% thanks to gains across most sectors. In fact, both US and local markets are at near 7 month highs thanks to improving investor sentiment.

Hidden within this broader measure of share prices are some even more exciting gains, as can be seen in Table 1. Healthcare has been the only sector to lose ground over the past three months, although to be fair this sector has held up better than most in recent times due to its defensive nature (people don’t stop using healthcare services just because the economy is slowing). In fact the four worst performing sectors over the past three months are all classified as defensive, and this suggests that investors are starting to switch their funds back into cyclical stocks, which in turn reflects that market participants are betting that the market may have bottomed.

Table 1. Performance of the major GICS sectors between 6th March and 4th June 2009

If we drill down to the level of individual stocks, we can see that there have been a number of spectacular gains amongst the blue chips. Typically, these kind of gains are not experienced in such a short space of time, especially when it comes to the larger, more established stocks.

Table 2. Top blue chip performers between 6th March and 4th June 2009

So does this mean that now is the time to get back into the market? Is the worst now over for investors or are we simply experiencing a bear market rally? No one really knows, and in reality we will only ever know for sure with the benefit of hindsight.

The reason I highlight this recent market strength is to point out an interesting irony that often acts to paralyze otherwise sensible investors. A peculiar facet of investor psychology is that there is often a significant disparity between what we think we will do in a given situation, and what we actually end up doing.

Back in March when the market was at a five year low, people were avoiding making purchases and quoting the maxim that you should never buy into a falling market. Most investors recognized that shares were cheap, but were fearful that losses would continue. Many investors said that they would only start to buy when things started to improve, and a new up-trend was established.

However when things did actually start to turn, fear and skepticism meant that many investors saw this as nothing more than a brief reprieve from the dominant downward trend. As the rally continued, the more it seemed inevitable that the market would soon turn, if for no other reason than profit taking. But amazingly even more influential factors, such as the lifting of the short selling ban, failed to prompt any significant downward move.

Now in early June, following three months of amazing gains, most investors are still reluctant to enter the market. People are saying that the “next leg down” is just around the corner, and that the recent gains are unsustainable with stocks heavily “over-bought”. Now people are saying that they will buy on the next pull back.

Regardless of where the market actually goes from here, you can see that there is an obvious disconnect between expected behavior and actual behavior. The tragedy is that most novice investors, especially those that have been burnt, will only be tempted back into the markets after prolonged and significant gains are observed. That is, after the majority of the recovery has occurred. Of course, this also means that these investors will be buying closer to the top of the market, when there is greater downside risk.

Attempting to exactly time the bottom of the market is a difficult and distracting task and is not essential to long term success. If you believe that the market will be higher when you plan on selling, then that’s all the justification you need to make a purchase. When it comes to investing it is not the journey that matters, but rather the destination.

Make the markets work for you

Andrew Page