What is the Rally Telling Us?

Those who forecast a V-shaped recovery point to the similarly sharp rebound in share prices during the past nine months, which suggests that investors see much better times ahead.

But is that what the current rally is telling us? Technical analysts have noted, for example, that volume has contracted as prices have climbed, which would seem to indicate that investors are becoming less, rather than more, convinced about the outlook.

And contrary to what occurred in some previous bull runs, those who would normally be among the first to see evidence of a robust turnaround — corporate insiders — have remained sizeable net sellers of their companies’ shares.

Also disturbing is the fact that the current rally has been marked by widespread speculation, including heavy trading in the shares of corporate disasters like Fannie Mae, Freddie Mac, AIG, and (the old) GM.

Does that mean these firms are going to lead the way forward as far as growth is concerned?

In a New York Times report, “When the Performance Looks a Little Too Good,” Mark Hulbert, citing research by San Diego-based Ford Equity, raises similar concerns about the frothiness of the current rally.

Since the March lows,…the 20 percent of stocks with [the] smallest market capitalizations have on average outperformed the largest 20 percent by 72 percentage points — only slightly less than the 85-point disparity between the lowest- and highest-quality issues.

By contrast, in the first nine months of all bull markets since 1926, the average outperformance of the small-cap sector was just 21 percentage points, or less than one-third as much as the disparity over the last nine months, according to calculations by The Hulbert Financial Digest.

Only once since 1926 have the first nine months of a bull market produced a gap greater than this year’s. That was in the bull market that began in February 1933, in the middle of the Great Depression, when small caps outperformed large caps by an incredible 196 percentage points.

How can we explain the current extreme performance disparity? The federal government’s stimulus program is the main cause, in the view of Jeremy Grantham, the chief investment strategist at GMO, a money-management firm based in Boston. Mr. Grantham said in an interview that by temporarily reducing the danger of incurring risk, the government had effectively encouraged huge amounts of risk-taking in financial markets. “The sizable disparity of junk over quality should not have come as a big surprise,” he said, “given how massive the government’s stimulus has been.”


When the Performance Looks a Little Too Good
Mark Hulbert
The New York Times, Dec. 6, 2009

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