By MoneyMorning.com.au
Last week, a massive liquidity injection from the European Central Bank (ECB) was the catalyst for change in market direction and sentiment.
While this has removed the immediate threat of a European credit crunch, it has not altered the underlying fundamentals. The Eurozone remains structurally flawed. I still believe that at some point you will see a breakup of the euro, led by Germany exiting the currency union.
Greece remains in an intractable debt problem. Portugal is not far behind. Without genuine debt relief (even the plan to reduce Greece’s debt ‘voluntarily’ by 50 per cent will not solve its problems) this saga will continue.
But debt relief means writedowns, which will trigger the payout of billions of euros in derivative insurance payments. The global banking system is not strong enough to handle such an event, so it will be avoided at any cost.
So don’t expect to see any meaningful reform in Europe.
Meanwhile, the market is acting as though the liquidity injection has solved the problem. Time and time again throughout this prolonged crisis the market has responded positively to central bank intervention. But time and time again the liquidity injection provided only a fleeting boost to prices.
I don’t expect things to be any different this time around.
The chart below shows the S&P500, the most important stock index in the world. Since the panic sell-off in August 2011, the S&P500 has advanced within a channel, identified by the blue lines. It momentarily broke below that channel in early October and then above it during the subsequent rebound in November.
It’s coming up against the top of the channel again. I think any break above it will be a false break and we’ll soon see a correction back down to the lower part of the channel. There is definitely strong momentum and sentiment behind global equity markets now. But given the still fragile fundamental economic backdrop, I expect reality to return soon.
The Australian All Ordinaries chart index looks a little different. The pattern of the past four months or so resembles a ‘bearish flag’ formation. In general, these formations serve to consolidate the moves of an existing trend – in this case a downtrend that began in April 2011. Once the consolidation period is over, the trend continues.
I’m not a chartist. But when you combine a weak economic outlook with fragile-looking charting action there’s good reason to remain cautious.
I still believe you’re seeing a pretty convincing bear market rally.
The bear market might feel like finding goods stocks is hard.
But keep in mind when searching for stocks, value and price are two different things.
With the market firmly focused on price, it’s easy to ignore (or not even care about) value.
As investors in businesses, it’s our job to focus on value not price. It’s very hard to do and not everyone’s cup of tea.
Put simply, when you estimate intrinsic value you’re estimating what a company’s really worth. This is different to its share price, which is only based on Mr Market’s emotional judgement – not rooted in sound knowledge of a company’s financial position or business fundamentals.
In the last few months, I’ve increasingly heard that value investing is useless in this environment. To be successful you need to trade and take a shorter-term view. That might work for some people. But it’s precisely at these times of great uncertainty that value investing can protect your wealth.
Greg Canavan
Editor, Sound Money. Sound Investments.
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