I was watching the penny stock rally last week when it suddenly struck me that its trading pattern was very similar to previous bear rallies in recent years.
Hadn’t we all been here before ? I started to wonder. I talked to a few old-time remisiers and it dawned upon me that we were going back to 2002 – a rather forgettable year when markets around the world mistakenly believed that they had finally put the excesses of the internet bubble behind them.
What is interesting is the manner in which penny stocks suddenly sprung back to life during the current rally on a raft of stories – construction firms getting a new lease of life from fresh contracts and heavily indebted China firms getting refinancing on their toxic bonds.
It bears stark resemblance to the 2002 bear rally when a different set of construction counters and China plays led the charge.
Well, going by the 2002 parallel, the markets did not bottom out for another 12 months when fears over the Sars crisis finally produced the sort of capitulation which was necessary to give markets the head-up for the rebound which transformed itself into a five-year bull-run.
It looks like my hunch is getting early confirmation with today’s market plunge. As I write, the benchmark Straits Times Index is down 60 points or 3.2 per cent, while the FTSE ST Small Cap Index, which tracks penny stocks, has slipped 3 per cent.
What is the trigger for the selldown?
It turns out that Bank of America’s first quarter results last night, while producing a profit, is reminding punters of just how sick the US economy is. Provisions for credit losses hit US$13 billion – a staggering US$5 billion higher than the previous quarter. The provisions also exceeded all the income it made from its core operations.
Like other US banks, BofA scrapped through with a profit because of bumper trading conditions, asset sales, fewer writedowns and some big fair value adjustment in its assets.
And an analysis of BofA’s results shows that US banks – the catalyst for the current six-week rally – are not exactly not of the woods yet. Credit conditions are deteriorating in US mortgages, credit cards and other consumer loans. The rot is also spreading to business lending and commercial real estate in the United States.
The resulting selldown in US financial stocks was sufficient to send Wall Street tumbling by 289 points – its worst one-day loss in seven weeks.
On the whole, newspaper market writers here have been sounding a note of warning about the current rally and stressing the need to temper any exuberance with caution.
In contrast, some research houses have turned almost rosy in their projections about the stock market, putting out bullish and frankly quite unrealistic forecasts on the STI.
Some cynics will say that these analysts have couched themselves sufficiently by saying that this is where they believe the STI to be 12 months from now, when their reports may already have been buried in the sands of time.
But the bull market is climbing on a wall of worry and business conditions have hardly changed all that much in the past six weeks when stocks had been partying like it was 2002 once more.
I feel that stock analysts are too quick to turn from bearish to bullish in the past six weeks. Bear market bottoms do not work that way.
As the 2002 parallel shows, it will take many months or even a year after a purported market bottom before market sentiment turns bullish again – and that again depends on the state of the real economy where the numbers are simply getting more awful as matters stand currently.
Take care.