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After such a traumatic – and prolonged – bear market, investors had become desperate to see a rebound. And March has delivered it, in spades, with the Dow Jones Industrial Average up 21 per cent since March 9, the S&P 500 up 23 per cent, and the Australian pair, the ASX 200 and the All Ordinaries, up 18 per cent and 14 per cent respectively.

Investors are torn between willing the market to go higher, and the temptation to take some short-term profits off the table. After all, it’s been a while since there have been any profits to snap up.

David Hunt, principal of Adest Trading and president of the Australian Professional Technical Analysts Association, called the bottom of the market, on March 11, at 3113 on the ASX SPI 200 (the Share Price Index 200, the ASX 200’s futures market alter ego). Hunt says the low came after the S&P 500 cash index completed a 61.8 per cent Fibonacci retracement area of the 1974 low, which took it to 688 points.

“It was easy to call, because everyone was so bearish, the world was ending, the Financial Review was telling everyone to get out of stocks, volume was dwindling into the low – it was a perfect set-up for capitulation. The signal was a pivot-point day on the S&P 500: it went to a new low in the retracement area, and then had an inside day – i.e., the index traded within the high and low range of the previous day and broke up. (An inside day is a sign to a trader that the security is taking a breather from the primary trend, or is in the early stages of a counter trend move.) It had done that previously, but not on a 61.8 per cent retracement of the entire range. Given the bearish mood, it was an easy call to make,” says Hunt.

But investors willing themselves that the bear market is over are likely to be disappointed, he says. “No-one is prepared to call a long-term bottom of the big bear retracement – there isn’t enough structure there to give you that safety. The potential for this March low to be the total end of the move is low – but it’s a good thing for a few months.”

Hunt expects to see a “pretty choppy, horrible manoeuvre upward” until late April/early May, followed by a possible new low into late May, and then a big rally from the end of May until September. That could take the ASX 200 as high as 5000 – but after that, I actually expect it to smash down to new lows.”

Fellow technical analyst Tom Scollon, chief analyst for Hubb Financial, is more interested in Bollinger Bands and Elliott Waves. Scollon is looking for the Bollinger Bands (which measure the volatility of a price series) to signal a build-up of demand, but believes the market has yet to complete an ‘Elliott Wave five low’ and thus set the stage for a sustained rebound. “I think we need to see a much deeper low before we can expect a more extended rally,” says Scollon.

Scollon says the Bollinger Bands (see Chart 1) around the All Ordinaries index are travelling sideways and parallel. “When Bollinger Bands do that, it shows a buildup of either demand or supply. If you look at Chart 1, if you look at mid-July through to mid-September 2008, the Bollinger Bands travelling sideways and parallel indicated was a buildup of supply, so it was setting itself up for the next leg down.

“In a bearish market, when price hits the upper band, it generally will fail. In the July-August 2008 period, each time the index went to the upper band it failed. The bands turning down and the price following them is a very bearish pattern, and that’s what we saw from September to December 2008. Since then, we’ve seen the bands level out, and the index trade within them, which hopefully indicates a build-up of demand. If in the next couple of the Bollinger Bands turn up, and price to rise within the Bollinger Bands – the reverse of what we were seeing in June-July 2008 – that means we could see a continuing short-term bear market rally.”

But Scollon believes the Elliot Wave five move will eventually take the market to a new low. “If you look at (Chart 2), the market is setting itself up for the next leg down. I put the reliability of that Wave 5 target of 2990 on the All Ordinaries) at 70 per cent. That’s a reasonably likely medium-term low for the next few months.

“Now look at Chart 3, which is a weekly chart: what we’re seeing there is a stronger wave five that takes the All Ordinaries down to 2520. The probability of the stronger wave, to 2520, slips away significantly – I would put it at less than 40 per cent. You can’t discount it, but it’s the most pessimistic possible outcome.”

If we see the index below 3000, says Scollon, there would be a growing belief among investors that we are near the bottom – and “a lot more volume” would come back into the market. “People intellectually understand that we’re seeing once-in-a-generation buys, but they have felt that the market is risky. At 3000 points, a lot of people would decide that the worst was out of the way and join the rally, because you can make potentially a 50 per cent gain up to 4500 over, say, the next year.

“At 3000, the risks of being out of the market become greater – whereas up until recently, the risk has come from being in the market,” says Scollon.

Talk to fundamental analysts, though, and they couldn’t be looking for more different things to indicate a bottom.

“There is only one sign that I would consider to be the bottom: the nationalisation of US banks,” says Peter Quinton, head of strategy at Bell Potter. “That would be the circuit-breaker to end the litany of bad economic news that has so battered investors.

“The Federal Reserve can quantitatively ease, it can buy Treasury bonds, it can support this, support that – but at the end of the day, until someone fixes insolvent banks, by definition, I think the stock market can’t show any sustainable recovery. You’ll get your bear market rallies, and we’re certainly seeing one of those at the moment, but generally speaking, if you want a sustainable pick-up in investor confidence and the sharemarket, you’ve got to do something about insolvent banks.

“Everything else is window-dressing unless they go to that step. The US really has to get its head around nationalisation, which of course is alien to everything they believe – and that’s the big problem,” says Quinton.

Simon Kent-Jones, investment strategist at Ord Minnett, does not go that far, but agrees that the markets need to see that the US financial system has been credibly repaired. “Once you start to see the financial system starting to clear, you will start to see credit markets unfreezing. Where there is government support, the spreads (the cost of borrowing) have come back in; where there’s not government support, areas like corporate debt – investment-grade and non-investment-grade – and asset-backed securities, you’re still seeing an elevated cost of borrowing. We’ve got to see spreads contracting in those markets before we can see a sustainable improvement in the sharemarket.”

Seeing global credit markets unfreeze and bank lending flowing again would show investors a credible sign of an end to the recession, says Kent-Jones. “That’s where the earnings cycle comes in. The market will be nervous coming in to the full-year reporting season, in August, and at this stage, I don’t think the market understands the contraction that we’re going to see in profitability.”

Kent-Jones says consensus numbers are expecting a contraction in profits for 2008-09 and a flat year in 2009-10. “To support a genuine recovery in the market, you’ll need to see greater clarity as to how far through the earnings contraction we are. We know the Australian market is trading on record low price/earnings (P/E) ratios and high dividend yields – which will eventually put a floor under share prices – but to a large extent the P/Es on which stocks are trading are a case of investors shooting in the dark until we see where actual earnings come in.”

Kent-Jones says the market will anticipate some of these improvements, but he believes there are “a few major things we need to see in place” before a genuine recovery can be mounted.

“Obviously we’re seeing a rally at the moment, but I think it’s a bear-market rally as opposed to a genuine recovery. I don’t think the steps are in place quite yet to see a genuine recovery – although I’m very happy to see the market rise,” he says.


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