What Will Keep The Rally Going?
November 1, 2001
The markets turned around abruptly on October 3 and have been on a tear ever since. So much so, that October is the best performing month since December 1991. The question now is whether this new trend will continue or whether the next big move in this market is likely to be another big lurch down.
If the October rally was mainly a technical bounce, powered by short-covering, then a correction is now likely, since many indicators of sentiment and momentum have moved from oversold to overbought. But short-covering alone is hardly a convincing explanation, partly because the losses of the summer were not nearly extreme enough to explain the biggest monthly bounce in 20 years. Moreover, the stocks that gained most were financials which regulators made literally impossible to short. Thus, it seems reasonable to conclude that something fundamental really happened in October to change investors‟ views, even if these fundamental drivers were then magnified by technical factors. Which brings us to the two big events of the month: the European “deal” on sovereign bailouts and bank recaps, and the strong economic and corporate figures, especially in the US. The almost unanimous consensus among media and market commentators has identified Europe as the main culprit. Our analysis, by contrast, has focused at least as much on economic and corporate earnings news from the US.
So what has been driving the markets—European politics or US economics?
In the first half of October, it was possible to argue either position, since unexpected improvements in US statistics were matched by widespread hopes of a decisive resolution of the Euro crisis. However, this situation abruptly changed. While the US statistics kept beating expectations, the European summit turned out to be massively disappointing. Not only did the EU leaders fail to agree on any of the specifics—the methods for Greek haircuts, bank recaps and leveraging the EFSF—but in contrast to all the previous indecisive summits, they did not even set any new deadlines for these all-important practicalities to be agreed upon. Even worse, the fact that so little was achieved, after the enormous build-up of expectations, clearly implied that agreement on the practical details was not just difficult but impossible under the present political circumstances in Europe. And then, to cap all these diplomatic disasters, the German constitutional court announced a temporary injunction against EFSF leveraging, while the Greek and Italian governments both declared that they would be unable to keep many of the promises they had made to their EU partners just two days before. Why then did the markets make record gains in what was by any objective standards one of the worst weeks in the history of Euro-zone diplomacy? Just as the horrible truth about the EU summit was sinking in, the US published a robust GDP report of +2.5% third quarter growth rate—which, after allowing for inventories, translated into +3.6% growth in final demand—dispelled fears of a US double-dip recession. This revival of US growth (the largest economy in the world) will, in turn, help emerging markets and could even take some pressure off Europe. In sum, we believe the evidence of a US economic rebound is the main reason for the equity rally and this trend should still have a way to go. If, on the other hand, the gains in equity prices are inspired by the “solution” in Europe, then more downward pressures on the equity markets lies ahead. We believe the former will prove to be the dominant case.
As always, we will keep a diligent watch on all events to protect and grow your assets here with us at Mowery Capital Management.
Fritz Mowery, President
Mowery Capital Management, LLC.
Source: GaveKal Research
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