Looking back through articles from earlier this year How Sold Are We and A Standard Rally, it is clear I was initially skeptical of the March low and subsequent rally. As will be illustrated later in this article, it is fairly safe to say the vast majority were of a similar view.
Come early July of this year however, there were simply too many bears returning to the fore. You didn’t have to go far to hear some fairly articulate arguments as to why the market would make new lows very soon and the economic conditions deteriorate from global recession to global depression. Contrarian theory states that at any one time, the market will not do what the majority of investors expect it to. Keeping yourself in the minority view can often be a challenge, but is certainly rewarding.
Chart 1 – ASX 200 July Bear Trap
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A similar pattern of sentiment appeared during the July rally and remains currently. The resounding opinion now seems to be that the economy is improving and the worst is behind us, but that the stock market has gone too far, too quick and is due for a significant pullback. It has been hard to read the finance section of a newspaper or website and not see this opinion.
Looking at retail investor’s current exposure to equities in Chart 2, it is clear that they have missed the current rally in Equities. Many are still mostly in cash. Anyone in that situation a month or so ago was quite naturally very keen on the idea of a new low so that they could pick up some bargains. It seems many from that camp have now moved to a view that they will buy on the next correction (fall of 10% or greater) and as a result are talking the market down either consciously or subconsciously.
Chart 2 – US Households - Equities % of Total Assets
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It is this expectation of a correction that suggests one may not be seen for some time yet. Not to mention global markets just had a correction of roughly 9-10% in June/July depending on which index you follow. Chart 3 highlights the size of that bearish move in price and percentage terms. This may act as a maximum retracement, at least until the market returns to the consolidation levels of July/August 2008.
Chart 3 – ASX 200 July Retracement
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It is safe to say that further shocks are likely as the market continues to digest the future outlook. Such shocks could bring some sharp retracements and challenges of support, but this appears a little way off if current sentiment is any gauge. Mind you I’m not going to be so coy as to say that after the rally we can expect a pullback. Of course we can, how else do we know the rally is over!?
The challenge now for those not invested is to avoid capitulation if a further rally does unfold. Invariably many will stop waiting for a retracement and buy at completely the wrong time. Such is the nature of the markets. So if waiting for a retracement is the plan, there is nothing wrong with sticking to it, even if the wait is painful. If we do see surprises to the upside in the next few months, we could well see surprises to the downside in the months after. These could return the market to around the current levels. Whatever the market does, the one certain thing is there will always be more opportunities tomorrow.