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Market bottom or bear rally?

By Tim Morris, Associate Equities Analyst, Wise-owl.com

Friday 18th April 2008

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Market enthusiasts should be breathing a little easier following a few weeks of relatively stronger trading. There seems to be an emerging chorus of analysts declaring that we have witnessed the market bottom. Although it remains to be seen whether this strength will be limited to a ‘bear market rally’, the technical picture paints a short term bullish outlook.

At the smaller end of the market, any recovery is likely to take longer. Delayed recoveries are typical of the small cap sector following market downturns, but the malaise may prove a bit harder to shake this time around in light of the Opes Prime collapse, which has created an ‘overhang’ on certain stocks. For those companies where the excess stock for sale by Opes’s creditors makes up a large proportion of shares on issue, one obvious solution is to try and secure new strategic investors, which has already been seen in some cases. However such a measure is likely to be limited to quality companies.

Despite the blue chips rally, many players in the market are still concerned about the potential for more write downs in the global financial sector. These concerns do have solid grounding, as it will take time for the ‘cleansing’ process to work its way through the financial system. However, the action being witnessed on the market confirms the wise-owl.com view that much of the gloom has been ‘priced in’, with the recent rally taking place in the face of UBS doubling its level of write downs to $US37bn. Also posting a first quarter loss of $US12bn, the Swiss based investment bank has skipped past Merrill Lynch to the top of the ‘league of write-down shame’. To seal its wounds, the bank is planning to raise $US15bn in fresh capital, bringing the total of emergency capital sought to $US34 billion, which is half its current market cap of $US67bn. With such negative news, it is easy to wonder how the market has managed to rally?

Aside from the fact that we were in very oversold conditions, the ability of these institutions to raise capital in such dire times has shored up investor confidence. Although the UBS raising has yet to occur, its rival, Lehman Brothers managed to raise $US3bn last week, which was oversubscribed. Over the past few weeks Lehman had been the subject of wild rumours that it was about to suffer the same fate as Bear Stearns, however this cap raising signaled the contrary in light of the strong investor support, which is why the market reacted very favourably to the announcement.

Local stocks also reacted well to the RBA’s decision to leave interest rates on hold last week. In its policy statement, the Reserve Bank softened its tone significantly compared to recent months, commenting that overall monetary tightening since the middle of 2007 has been “substantial” when both official changes to the cash rate and tight wholesale credit conditions are taken into account. The Reserve highlighted that growth in domestic demand is moderating in light of softening business and consumer sentiment, and credit demand during 2008. As domestic economic conditions moderate, so will the case for more rate rises. There has been a lot of speculation about whether the RBA’s tightening cycle has now run its course, however mortgagors shouldn’t hold their breath, as inflation will be the critical determinant. An easing in domestic demand should serve to cool inflation; however the flow on effect will take time.

Controlling inflation is a challenge not limited to Australia, as booming soft commodity prices are putting pressure on food prices around the world. Last week’s action on the agricultural markets saw the price of rice climb to record highs in excess of $US20 per hundred pounds. Like all agricultural commodities, rice prices are historically cyclical, however current prices almost double their traditional cyclical peak around $US11.50 per hundred pounds.

The latest surge has been attributed to news that Vietnam, one of the world's three biggest rice exporters, is set to cut back exports this year to 4 million tons to shore up domestic supplies and curb inflation, which is at its highest in more than a decade. The government also said it's considering a tax for rice exports to discourage a drain from the domestic market.

Time to cut back on the Asian cuisine, perhaps?


About wise-owl.com
Wise-owl.com is Australia's leading independent research house providing investors with investment strategies and education on the stock market.

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