We don’t know whether the equity rally is over
IS the equity rally over? It’s the question on everybody’s lips and one we still don’t have the answer to. However, the balance of probability is that we may have already seen the best from this push higher. Indeed, I would go as far to suggest that this was just the warm up and that real deal is still someway down the road.
What is now clear is that last week was pivotal in the undoing of this little dash higher. If you pull out a three year chart of the S&P 500 and find yourself a ruler, you can quite clearly see that this upward move had started to bump against a downward trend that has been in place since October of 2007.
I appreciate that this is charting at its most basic level but it does seem to work. If you want to get a little more sophisticated, overlay a simple 200 day moving average onto the chart and you get a very similar result.
However, aside from what the charts tell us there are some more fundamental reasons why we are seeing this retracement.
First up is what was driving the rally – the financials. Now I appreciate that there was a case for re-valuing this sector but not this much. As Credit Suisse and others have pointed out, the underlying story for the banks is by no means as rosy as this rally would suggest.
Margins will be under pressure at these institutions for sometime to come and there will undoubtedly be further writedowns as the economy continues to suffer.
The reason, I suspect, that the sector flew too close to the sun was that so few managers had the banks on their books and when they took off there was panic buying.
So what happens next? Well there seem to be two schools of thought.
Firstly we go down by five per cent and then shoot higher, which will be very painful for the bears.
The alternative is that we retrace by at least 15 per cent and trade there until the economic indicators are strong enough to justify the wall of real money sitting on the sidelines getting involved. If this is the case then I doubt it will be the firms at the bottom of the barrel that will lead the charge.
Guy Johnson co-anchors European Closing Bell and Europe Tonight, weekdays on CNBC