Business And Leadership, Ireland's Business News Service

Is this a false dawn – a bear market rally – or something more sustained that investors can get their teeth (and their investments) into? The answer, of course, is that no one can be sure. However, it appears that a growing number of analysts are beginning, at least, to cheer the bottom of the cyclical bear market. The next swing, they insist, is a cyclical bull and for some it is even better that that – a full-blooded beginning of a structural upswing.

 But investors may be cautious despite these predictions. These analysts are almost by nature bullish and are, of course, also talking their own books. It is true, nonetheless, that the most recent rebound is certainly of a greater magnitude than the previous five over the past 18 months or so, but it could still be akin to the false dawn between late 1929 and spring 1930. More investors lost money back then, trying to catch the falling knife that was the stockmarket, than lost their fortune in the original crash.

Bearing that in mind, we canvassed the views of some leading strategists. Bernard McAlinden, equity strategist with NCB, is one of the bulls at least on a cyclical basis. He insists that the cyclical bear market has reached bottom and, while we may not yet be in a bull, it is likely by the end of the year.

Is the worst over?
The man who coined the phrase the Celtic tiger, Kevin Gardiner, head of global equity strategy at HSBC, also believes that the worst may be over. He recently told the Financial Times that the arithmetic reality – how much of the slowdown may now be behind us – may yet come as a positive surprise.

“Talk of an above-trend growth rate in output and profits appears to flirt with financial heresy – but it may not be as outlandish as it sounds. Not for the first time, our collective expectations may largely reflect the picture in the rear-view mirror,” he says. “Even allowing for some stability during the rest of 2009, it is quite likely that we shall soon be looking back at the weakest five- and 10-year trends in the past half century. There may now be as much room for these moving averages to accelerate as there is for them to fall further.”

He believes that this is particularly true of all-in measures of corporate income, where incremental growth rates from the third quarter onwards may reflect a move out of loss and into profit – at a speed that will be turbo-assisted by financial base effects.

Bernard Swords, chief investment officer at Goodbody Stockbrokers, is also in broad agreement. He believes that we saw the lows of both markets and economies around January or February in global markets.

“Since then, we have seen a steady improvement in US business sentiment, while the housing market is going sideways in activity and sales levels.”

Swords admits that it is more mixed in terms of consumers. “But I think this recent stall in consumer sentiment is just a short-term pause on the consumption side. So, from the economic indicators we look at, we expect US growth to turn positive in June or July.”

Caution advised
Nonetheless, argues McAlinden, caution is advised. He is careful to point out that we may still be within the longer-lasting rolling wave of a structural bear market, which has been ebbing and flowing in a generally downward direction for the past eight years. If so, this would mean that even a cyclical upturn now would be followed by further falls – perhaps even a year or two out.

“The point I would make is that if you believe the market will not make new highs and we are still in a structural bear market, at some point there will be a shorter-term cyclical uptick. If you had known in 2002/2003 that we were still in a structural bear, and had stayed out of the market, you would have waited five years to make money and lost a potential 88pc return.”

McAlinden points to signs of the world economy beginning to emerge and to a pick-up in economic sentiment. “It is tentative,” he admits. “But purchasing managers’ indices (PMIs) in both manufacturing and services have bottomed out, while consumer sentiment looks as if it may have done so. History tells us that when the PMIs reach bottom, this correlates strongly with GDP growth bottoming.”

The main risk, according to McAlinden, is deflation, given that central banks cannot reduce rates below zero, so there is upward pressure on real rates. “The big unknown is whether we are doing enough. If we look at history, we have always had a policy response and rates have come with fiscal action at times and, once in Japan, quantitative easing. All policy responses have worked to some extent, it is a question of for how long. This time we need all three so we are betting that fiscal stimulus and quantitative easing can make a difference.”

In terms of the differences between markets McAlinden points out that in an increasingly globalised world all markets tend to act in concert. Nonetheless, he views the world as divided between those who extended credit and those who took it. Germany, China and Asia fit in the first bracket and the US, the UK and Ireland in the latter. The former will lead the recovery, argues McAlinden. “When the dust settles, we will find that the German consumer is on a much better footing and they will lead Europe out.”

In contrast, Swords argues that the markets to invest in are the US and the UK. “Economically, the eurozone is a bit behind. The US will be first to turn around and European economies are more dependent on world trade, so it will be later before that feeds into European economies.” He is buying UK consumer stocks, such as Mitchells and Butlers, as well as Debenhams and house builders such as Persimmon.

Defensive strategy
For those who believe that loss will be visited again, McAlinden would invest in defensive stocks that benefit from growth in China and elsewhere such as steel companies that are world players or in mines and so on. However, he argues that if you believe we have reached a cyclical bottom, then the cyclical stocks are cheap. This means motors, airlines, building materials, banks, utilities, pharmaceuticals, healthcare, food retail and so on are probably less hair-raising and a more middle-of-the-road option.

“But I would leave a place for deep cyclical, such as cars and airlines, on the basis that they will not disappear off the face of the earth. Banks, on the other hand, are a ‘brave thing to have’ and because of the severity of the cycle you could lose everything in bank stocks.”

Swords still has a reasonably defensive basis to what he is buying. However, he is not buying metals or engineering, which he says have rallied a lot and may well fall back. Neither McAlinden nor Swords are buying Irish stocks apart from the likes of CRH and Kerry, which have a global brand when they dip.

But McAlinden does have a get-out-of-jail card. “My best guess is that we have seen bottom. The markets could fall back again, but they will not go through the old low in March.”

This article first appeared in Irish Director magazine