Sinking feeling over global 'recovery'

LONDON - Can it really be over? Are those nerve-shattering days of financial panic merely a memory? The stockmarket seems to be have been telling us so after a swifter, harder rally in share prices than anybody had dared to contemplate.

Before dipping this week, The FTSE 100 in London had rallied 33 per cent since hitting lows in March.

On Wall St, the Dow Jones Industrial Average had gained a startling 42.4 per cent to 9321 since it bottomed out at a 12-year low of 6547 in March. The broader Standard & Poor's 500 index broke a psychologically significant barrier this month by reaching 1000 points for the first time since November.

A quick glance down a list of popular shares shows just how energetic the bounce has been. On the FTSE 100, HSBC has doubled since the market's low point. In the US, Macy's has leapt 128 per cent and Apple's stock has doubled.

The golden question is whether it can last. To date, the market's recovery has been V-shaped but a further shock could well turn that into a W.

Yesterday, global shares fell. The Dow Jones dropped 2 per cent, the S&P 500 2.4 per cent and London's FTSE 100 fell 1.5 per cent.

A growing number of experts are beginning to worry that the rally has set off too fast and could run out of steam.

"It is extremely dangerous to have a rally of 35 per cent over six months without a pull back," says David Buik at BGC Partners in London. He predicts the dollar will strengthen, knocking oil, other commodities and US equities, and therefore other stock exchanges.

Still, the FTSE has further to go before the end of the year, Buik predicts. "As a result of [investors' approval for] cost-cutting exercises and huge redundancy plans the FTSE will probably hit 5100 by the end of December."

Strategists at Morgan Stanley have analysed 19 previous long-term bear markets, including the US in the 1930s and Japan in the 1990s, to gain some insight into where markets may be headed.

They found the usual rebound rally is 71 per cent over 17 months. Given Europe is now up some 40 per cent from its trough, in five months, "if it ends here, it would have been a very small rebound rally," they note.

The bank's equity strategist Graham Secker sees further gains for the FTSE 100 for the rest of this year. But the rally will be in the order of a modest 10 per cent.

"Our view is, the market can continue to grind higher, rather than soar higher, until we get close to a new cycle of higher interest rates."

In the meantime, investors will have to get used to volatility. This year has seen four cycles so far: the plunge in February and March; a rally, a fallback in June; and then the current rally. At ground level, the picture is still a miserable one. Unemployment in Britain has surged to almost 2.5 million, the highest since 1995.

The economy contracted faster than feared in the second quarter and the Bank of England warns recovery could be "slow and protracted".

Although US unemployment was not quite as bad as expected in July, employers still axed a quarter of a million jobs. A record 360,000 homes faced foreclosure proceedings last month, and retail sales dipped by 0.1 per cent.

But there are some justifiable grounds for the market's recovery.

Widespread relief that the world was not spiralling into a 1930s-style depression prompted the rally in March and April. Good earnings reports are the big driver in this latest surge. The credit freeze has begun to thaw and the markets have had a lift from the sheer volume of cash pumped into the economy by central banks.

But stockmarkets still face some big questions.

"The cyclical variables are increasingly favouring the market. The structural issues still remain problematic," says Jim Reid, head of European equity strategy at Deutsche Bank.

"Governments are heavily borrowing from the future to stop the short-term implosion and you've got a banking sector which is still bloated."

If government bond yields start to rise, shares will lose some of their shine. Reid predicts banks and consumers will not be able to take up the slack and we will see "notably lower equity markets".

Andrew Milligan, head of global strategy at Standard Life, also sees a number of tensions in stock markets.

"For a couple of weeks now there has been a growing rumble within the broking community that this rally looks like it is getting long in the tooth," he says.

"It would be no surprise at all to see a market correction."

Barclays Capital's chief US market strategist, Barry Knapp, says one concern is that the original slow-motion market crash, between October 2007 and March 2009, was not as dramatic as it might have been.

"Our base premise is that we never really believed the market got exceedingly cheap," says Knapp.

"Expecting a long period of above-average returns over the next couple of years is unrealistic."

Technical calculations add to a picture of stocks in a hurry. Mary Ann Bartels, chief US market strategist at Merrill Lynch, says an unusually high 88 per cent of US stocks are above their 200-day moving average. This ratio last reached 90 per cent just before a market correction in March 2004. She predicts that stocks could slip back by 15 per cent to 20 per cent.

For many analysts a concern remains that instead of achieving better sales, many companies have simply cut costs with ruthless efficiency.

"You cannot build the success of a stock market on cost-cutting exercises forever and that is my concern," says Buik. "I see a W recovery because I am very, very concerned about the borrowing of this country ...

"There's no question disposable income will drop and that will affect retail - and that will see us back into some kind of mini-recession before we come out of it."

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