After winter’s rain and ruin, market behaviour over the past two months broadly mirrors a seasonal resurgence. But investors are unsure whether this warmth will last or if it’s all just a desperate pathetic fallacy.
Assuming that the big picture view for emerging markets is still valid, with the fall in stock prices November 2007 onwards representing a cyclical bear market within a secular bull run, the low hit in mid-March this year should indeed mark a major turning point.
Cyclical bear phases within other secular bull markets in post-war history typically lasted five months and peak-to-trough declines averaged 25%.
In the current cycle too, emerging markets dropped 25% from the high reached on October 31, 2007 to the low hit on March 18, 2008. Since then, the asset class has strongly bounced back, suggesting a trading pattern that is consistent with the history of secular bull runs.
Assuming that the big picture view for emerging markets is still valid, with the fall in stock prices November 2007 onwards representing a cyclical bear market within a secular bull run, the low hit in mid-March this year should indeed mark a major turning point.
Cyclical bear phases within other secular bull markets in post-war history typically lasted five months and peak-to-trough declines averaged 25%.
In the current cycle too, emerging markets dropped 25% from the high reached on October 31, 2007 to the low hit on March 18, 2008. Since then, the asset class has strongly bounced back, suggesting a trading pattern that is consistent with the history of secular bull runs.
Gold prices in the 1970s, Japan
Despite these parallels to history, hardly any market strategists are feeling sanguine about markets due to all the uncertainty regarding global growth prospects and the worrying inflation outlook in many developing countries. Most stock research analysts are also still busy downgrading their earnings estimates for companies.
This raises the question of how can stocks possibly rally in the face of earnings downgrades and a soggy macroeconomic outlook? Well, stock prices almost always move ahead of projections by analysts and economists, especially at the turning points of a cycle.
At previous inflection points in global equity markets, stocks often rallied six months before analysts were done with the downgrading process. Therefore, the commentary of economists on inflation and earnings research by company analysts is currently useful only for the purpose of rear-view mirror driving.
A re-rating of markets is the more important driver of returns in the recovery period of a secular bull trend. Valuation measures such as the price-to-earning or P/E ratio are very sensitive to changes in inflation and interest rates and usually expand first in anticipation of a better economic outlook and earnings growth follows later.
Many emerging markets rallied over the past two months as monetary authorities in their respective countries either indicated a pause in interest rate hikes or the nearing of an end to the tightening cycle.
But a view on commodity prices is critical in making any interest rate and stock market forecasts since the surge in the commodity complex is the main source of the global inflation problem.
A levelling off in commodity prices will ease the pressure on central banks in developing countries to tighten monetary policy further whereas a further escalation will prompt a new wave of rate increases and consequently another leg down for those equity markets.
Despite these parallels to history, hardly any market strategists are feeling sanguine about markets due to all the uncertainty regarding global growth prospects and the worrying inflation outlook in many developing countries. Most stock research analysts are also still busy downgrading their earnings estimates for companies.
This raises the question of how can stocks possibly rally in the face of earnings downgrades and a soggy macroeconomic outlook? Well, stock prices almost always move ahead of projections by analysts and economists, especially at the turning points of a cycle.
At previous inflection points in global equity markets, stocks often rallied six months before analysts were done with the downgrading process. Therefore, the commentary of economists on inflation and earnings research by company analysts is currently useful only for the purpose of rear-view mirror driving.
A re-rating of markets is the more important driver of returns in the recovery period of a secular bull trend. Valuation measures such as the price-to-earning or P/E ratio are very sensitive to changes in inflation and interest rates and usually expand first in anticipation of a better economic outlook and earnings growth follows later.
Many emerging markets rallied over the past two months as monetary authorities in their respective countries either indicated a pause in interest rate hikes or the nearing of an end to the tightening cycle.
But a view on commodity prices is critical in making any interest rate and stock market forecasts since the surge in the commodity complex is the main source of the global inflation problem.
A levelling off in commodity prices will ease the pressure on central banks in developing countries to tighten monetary policy further whereas a further escalation will prompt a new wave of rate increases and consequently another leg down for those equity markets.
The good news is that except for oil, most other commodity prices have largely tracked sideways since mid-March after rising in a parabolic way from August last year. If the past is any guide, then oil prices should also begin to subside soon as the fundamental backdrop is deteriorating for this commodity as well.
Until late last year, the rise in commodity prices — including oil — mainly reflected the economic demand surge in the developing world and so did not pose a problem for markets. But over the past six months while demand has slowed markedly in the developed world and softened (even if ever so slightly) in the developing world, commodity prices have gone on to rise at the fastest pace in recent history leading to the inflation problem.
Research shows that commodity prices always lag the economic cycle and start to fall in earnest only four to five months after a major economic slowdown sets in. Admittedly, over the past decade emerging market demand has come to be the most important factor in determining commodity trends.
But changes at the margin matter the most in driving prices andUS US consumes just under a fifth of the total global oil output and latest data reveal that oil demand in the US
Even as a strong consensus is building for the view that “It’s different this time”, lower demand from the developed world is in the process of changing the fundamental dynamic on the commodity marketplace. The only wild card that poses a risk to a projection based on pure fundamentals is market psychology.
Towards the end of any major trend, prices can often get disconnected to fundamentals for a while as all sorts of spurious arguments are used to bid prices almost endlessly higher.
Such a feeding frenzy is building in the oil pits with old news about supply disappointments in places from Russia to Nigeria being bandied about to drive prices higher while data that show increasing inventory levels and falling demand are finding little purchase.
Similarly, financial flows into commodity-related products have risen by manifold over the past year.
Rising oil prices are currently the biggest obstacle in the way of stock markets rallying any further. Much of the bad news regarding theUS
However, a runaway increase in oil prices poses the risk of spurring on other commodity prices all over again and triggering a second-round effect on inflation.
Headline inflation in many emerging markets is already outside tolerance levels and policymakers are on the edge regarding further monetary tightening.
If the fundamental factors of slowing oil demand and no major supply disruptions reassert themselves then oil should start to retreat.
Lower oil prices will ease inflationary pressures and allow equity market valuations to expand again. In short, for the script of a secular bull-run in emerging markets to remain on track, commodity prices led by oil need to come off the boil, pronto.
Until late last year, the rise in commodity prices — including oil — mainly reflected the economic demand surge in the developing world and so did not pose a problem for markets. But over the past six months while demand has slowed markedly in the developed world and softened (even if ever so slightly) in the developing world, commodity prices have gone on to rise at the fastest pace in recent history leading to the inflation problem.
Research shows that commodity prices always lag the economic cycle and start to fall in earnest only four to five months after a major economic slowdown sets in. Admittedly, over the past decade emerging market demand has come to be the most important factor in determining commodity trends.
But changes at the margin matter the most in driving prices and
Even as a strong consensus is building for the view that “It’s different this time”, lower demand from the developed world is in the process of changing the fundamental dynamic on the commodity marketplace. The only wild card that poses a risk to a projection based on pure fundamentals is market psychology.
Towards the end of any major trend, prices can often get disconnected to fundamentals for a while as all sorts of spurious arguments are used to bid prices almost endlessly higher.
Such a feeding frenzy is building in the oil pits with old news about supply disappointments in places from Russia to Nigeria being bandied about to drive prices higher while data that show increasing inventory levels and falling demand are finding little purchase.
Similarly, financial flows into commodity-related products have risen by manifold over the past year.
Rising oil prices are currently the biggest obstacle in the way of stock markets rallying any further. Much of the bad news regarding the
However, a runaway increase in oil prices poses the risk of spurring on other commodity prices all over again and triggering a second-round effect on inflation.
Headline inflation in many emerging markets is already outside tolerance levels and policymakers are on the edge regarding further monetary tightening.
If the fundamental factors of slowing oil demand and no major supply disruptions reassert themselves then oil should start to retreat.
Lower oil prices will ease inflationary pressures and allow equity market valuations to expand again. In short, for the script of a secular bull-run in emerging markets to remain on track, commodity prices led by oil need to come off the boil, pronto.
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