An independent professional's take on the latest news and trends in global financial markets

Too Early To Panic (Though Some Are)

After another turbulent week in the markets, it seems a good point at which to stop and take stock of where we are. Equity markets are now oversold and will certainly have a bounce soon, for sure. Readers of Independent Investor will know that Jim Rogers thinks this is just a normal market correction, after the strong run from February to April.

Crispin Odey thinks the trend is still upwards. Ken Fisher does so likewise. Sanjeev Shah, Anthony Bolton’s successor at Fidelity, also thinks the market is oversold and has bought some more units in his own Special Situations fund – always an encouraging sign.

In a short Q and A last week, Richard Oldfield, the founder of Oldfield Partners, a specialist equity fund manager which has no public profile but is much admired by those who know it, is keeping his pro-equity bias in place, though he also said that he has learnt to ignore at this peril technical indicators such as Investors Intelligence’s bullish/bearish sentiment indicator, which has been flashing a clear warning sign.

So, at the very least, even if you don’t dare to be bullish, don’t be fooled by dramatic media headlines into thinking that the equity market rally is necessarily yet over. The crisis in the eurozone is real enough, and has been confounded by the unimpressive response of Europe’s political leadership to date. There is no doubt that there is an element of investor panic out there in the response to the unfolding eurozone crisis.

You can see this in a number of different indicators. The VIX index, which is often used as an indicator of fear in the market, has risen sharply in the last two weeks.

More worryingly, so too has the Libor rate, the key interbank lending rate which can also be interpreted as an indication of how willing banks are to lend money to each other.

This underlines the fact that behind the worries over the eurozone is the fear of further banking collapses. The rescue of the Spanish bank this weekend underlines how weak many lenders in the eurozone still are.

If banks start to stop lending to each other again, and liquidity dries up again because of fears over bank solvency, we will heading back towards a new crisis.

The technical condition of the stock market has deteriorated in the last few weeks. Richard Russell, the doyen of all technical analysts, now in his ‘80s, reports from his San Diego home in dramatic tones that the stock market has entered a primary downtrend.

All this may help to explain why Philip Gibbs, the financial expert at Jupiter, moved a lot of his funds out of equities and into cash earlier this year, fearful of the impact that the new crisis over sovereign debt might have. Against is the fact that Jupiter has announced last week its intention to float on the stock market, not something the firm would presumably try if the hugely influential Mr Gibbs was as bearish as he was in the run up to the 2008-09 banking crisis.

The risk of a new financial crisis, as has been noted here before, has never gone away, but the odds against it happening have been lengthening. Now the odds have taken a hit back in the opposite direction. A new crisis can still be avoided, but investors need to be aware that the possibility remains, even if it is still more likely that the equity market will start to pick up, as it was clearly beginning to do on Friday before news of the Spanish bank rescue.

While I remain confident that the case for equities remains robust, therefore, it is clearly sensible to remain alert to the danger of a new crisis, and be prepared to act accordingly if the market fails to bounce back. The next couple of weeks will give us more clues as to whether another dramatic stock market crisis is imminent.

Written by Jonathan Davis

May 24, 2010 at 8:33 AM