As was pointed out to me in one of the comments following my last article there are some signs that the market has become increasingly resistant to bad news. Indeed, it is encouraging that a host of weak economic data, more bad news on the banking sector front, bickering by leaders ahead of the G20 meeting, and the likely bankruptcy of a couple of US automakers has not prompted a more negative reaction.
Is the market tired of selling? It’s highly possible. Having faced an onslaught of bad news over recent months perhaps market players are simply exhausted. Adding weight to this is the fact that any pullback in equities has been relatively small compared to the gains over recent weeks whilst technical indicators are suggesting a more positive picture emerging.
I am not convinced. I will grudgingly admit that the market looks in better shape than it has done for months but this is far from a sustainable rally. Retail investors have yet to get in on this rally and like past equity crashes such as that following the Nasdaq bull burst, it took a long time for many investors to get back into the market having been burned so badly on the way down.
As I write this the US ISM manufacturing and pending home sales data have been released and both have come in on the positive side of expectations. The caveat is that the ISM is still in contractionary territory, consistent with falling GDP. Even if the data coming out now is less negative economic stabilisation is unlikely to take place until at least the end of the year. Based on past trends equity markets begin pricing in recovery around 6 months ahead of actual economic recovery, suggesting that we may only be a few months away from a more sustained turnaround in equity markets.
My only concern with this theory is that this is unlike any previous recession and so the equity market signal may be false. The current US recession has already lasted around 16 months, which is already a few months longer than the average for past recessions. It will need banks to be healthy before the economic outlook improves. If banks continue to remain in bad shape then past history will be a poor guide to the current path of the US economy.
ECONOMETER 