Caution Should Always Be The Rule

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The Stock Markets are out of control, the uninterrupted run up continues and investors do not seem to care. I am concerned because I can’t find any argument to justify buying at these levels and I say this from past experience. When there is no reason to buy, the risk of a severe correction or even a crash is high. As I have said repeatedly, this current stock market behaviour reminds me of 1999 just before the crash. In those days investors were euphoric about a particular asset class, technology stocks. They ignored the “old economy stocks” or the traditional component of the FTSE 100 index, instead they focused on the “new economy stocks” and technological advances. Over-excited investors bought everything related to software, e-commerce and the Internet without properly assessing valuations, prospects or dynamics.

© Mike Hodges

Today investors are ignoring the negative factors which are a serious threat to the bull market, instead they are focusing on the wave of stimulus around the globe. Similarly to 1999, investors are driven by euphoria, as if nothing matters except the Federal Reserve’s printing press. This extreme in optimism is such that some long term bears have now turned bullish.

Yet there is something amiss about the current rally. Logical questions concerning underlying fundamentals are not being asked, questions like:

1.    Why is volume declining and not rising? In a bull market volume expands when prices rise.
2.    Why is the price of metals down? In a bull market metals and mining stocks go up inherently with the stock market.
3.    Why is the economy still weak after 5 years of stimulus? Surely by now the economy should be firing on all cylinders.
4.    Why is inflation not picking up? Yesterday’s reported PPI and CPI numbers were very weak.
5.    Why is the current run up occurring now? We saw a similar uninterrupted rally in July 2009 but that was understandable, the economy was recovering from the 2007-2008 financial crisis. Today there is nothing to recover from, in fact the economy has been recovering for the last four years.

But the most important question that nobody is asking is – given the current conditions, is this rally sustainable? The answer is no. Year to date the FTSE is up 15%, that’s equivalent to more than 40% per year. Now if you check the stats you will see that the FTSE has never gone up by 40% in one year. The highest return was 35% in 1989. Even during the great bull market of 1990-2000 the FTSE never rose by 40% in a year. So if history is a guide to go by then the FTSE has gone too far too fast.

There is no need for investors to get excited for further gains in 2013, as the prospects in the second half of the year do not look encouraging. For now, I am happy to go with the trend but ready to my change view as it’s beginning to feel more and more like a bubble.

Thierry Laduguie is Market Strategist at www.bettertrader.co.uk

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