Eastern Promises, Western Doubts

06/29/2009 12:01 am EST

Focus: GLOBAL

David Coffin

Editor, Hard Rock Analyst

While the developed markets meander, China and India keep motoring higher, write David and Eric Coffin of the Hard Rock Analyst. But how long can it last?

As we move through June, markets look less and less decisive. Large-cap indices have flattened out and look like they are slowly rolling over. All the commentary about how large the bounce has been off the March lows belies the fact that most of the bigger bourses really haven't gone anywhere since early May. The truly impressive aspect of this to us has been the down shift in volume. It has been falling almost constantly for several months. 

The volume levels in [the first quarter] may not be a good comparable, since the markets were still in panic mode and (one sincerely hopes) capitulation. Current low volumes do speak to a definite lack of conviction on the part of traders, however, which is mirrored by indices that seem to be meandering almost aimlessly. Larger exchanges contrast with a number of developing-country indices, like Shanghai, which continues to be on a more direct upward trajectory. The chart for the Bombay Sensex looks considerably more bullish than even Shanghai ever since voters handed Prime Minister [Manmohan] Singh a stronger mandate [in the May election]. Some will view this simply as a danger sign where the Chinese and Indian stock markets are concerned. Yes, they do look frothy, but we also consider their greater strength another aspect of the new world order that is now evolving.

There has been a lot of comment recently that this is a "retail" rally, but recent figures from Trim Tabs, a firm that monitors fund flows, indicate there has been little retail participation. The "retail only" argument tends to get proposed by those that are fundamentally bearish. The underlying assumption is that funds are smarter than the retail crowd, so if the funds aren't all in, it must be a head fake.

After the past two years, we're surprised so many still assume superiority on the part of fund managers. Low retail participation and tepid volume can be read either as an indication that there is lots of money on the sidelines waiting to get in (if you're bullish) or that retail investors have thrown in the towel and blocked their broker's phone numbers (if you're bearish).

The second answer may be closer to the truth. There was a lot of money pulled out of equity funds in [the first quarter] and moved to money market and bond funds. That doesn't mean these people (and funds) are gone for good. If it turns out this rally is not a giant head fake and the markets just keep rising, those disillusioned traders will be back as things get frothy again.  

We still think a major correction towards the March lows is the [most likely] outcome. We can't help but look back at the aftermath of the Tech Wreck, which produced a sizable multi-month rally only to be followed by lower lows. Given the extreme oversold levels in March, however, we are still not assuming those levels will be reached and breached this time.

It's worth remembering that the most common movement during long bear markets is actually sideways and that they can be flat and boring for long periods. We are also well aware that the market's job is to make as many pundits as possible look stupid, and virtually everyone is expecting an imminent collapse. That alone makes the contrarian in us wonder even though the signs do point downward in the major markets.

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