Despite the recent market rally in the wake of the Kuta terrorist attack, the global outlook still looks volatile
The four days that changed the world: is that what we saw last week? After the Bali bomb, most equity markets shot up 10% or more, the fastest rise over such a period for almost 10 years. Market sentiment is more than usually unpredictable. In the weeks leading up to the first anniversary of the 11 September attacks, the Dow Jones index was rising. When the day passed with no further terrorist outrage, it fell.
Analysts and experts will always say it is impossible to call the top or bottom of the market but in fact spend much of their time explaining why they cannot or have not, which involves them in the very analysis they deny doing. A week ago, attention was being drawn to record volatility, which in 1973/4 marked the turning point for markets. In the following eight weeks, the index doubled.
Then, as now, war and conflict were factors. But the attack on the Kuta nightclub has probably crystalised political strategy. If there were any doubts about the ongoing threat from terrorist networks, they are going to be voiced more quietly. The US is able to say to the wobblers: 'I told you so.' If regime change in Iraq is step one in a programme to block further attacks, so be it.
So going into the New Year, the price of oil must rise, no matter how many guaranteed suppliers there are. Gold is already knocking on the next resistance level of $326/ounce, ready for another run higher. The dollar is supposed to be a safe-haven currency, but with the US trade deficit at 5%-6% of GDP, it must face reality at some point. Sterling is the next best option, given the ever disappointing performance of the euro, which has again dipped below parity with the dollar.
But back to the equity markets. No one wants to miss the turnaround, but could this seriously be it? Investors appear to have gone into deep denial, ignoring any bad news and focusing exclusively on the positive. A few US companies reported decent figures last week, perhaps even ahead of expectations, but surely people are aware of how expectations are managed in the current environment?
If you tell someone their investments are underwater and their future is uncertain, they are likely to weep tears of joy when you adjust your outlook to 'difficult with some sunny patches'. The hurdle rate is so low they will rush out and buy, grateful that life can continue. Bad news is still punished severely, but good news is being rewarded disproportionately. So warm feelings towards IBM and Nokia's results shut out disturbing news on US job losses and worsening credit quality.
No-one wants to consider the latest rally a false dawn. They feel they have suffered enough. There is sufficient money around to create the impression of sustainable demand, although much of it represents hedge fund activity. Safer ground is tantalisingly close: the FTSE 100 could soon be through the next key resistance level. If it stays above 4,500, investors might be tempted to shift out of bonds and back into stocks.
But the fact is that the Dow Jones still has some way to go before it approaches fair value. We have had the internet bubble and the telecoms bubble, but like peeling the layers off an onion, there may be more to go through ' a dollar bubble, a property bubble and, the last bastion of them all, the US consumer bubble. Four days have not changed the world.
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