It has been a testing month or two for stock investors with most stock markets experiencing major corrections. However, the recent recovery in stock prices and suggestions of a possible end to interest rate hikes by the Federal Reserve have given some investors hope that markets are past their bottoms, a hope that, unfortunately, may not be well founded.
After a steep fall in May and early June, stocks recovered a little in the second half of June. 29 June in particular saw the Standard & Poor's rise 2.2 percent, its biggest one-day percentage gain since October 2003. The S&P 500 was flat for June as a whole but is now up 1.8 percent since the beginning of 2006.
It is a similar story in other markets. Japan's Nikkei 225 edged up 0.2 percent in June, Britain's FTSE 100 rose 1.9 percent while the volatile Sensex index of Indian stocks climbed 2.0 percent.
That leaves most major stock markets in positive territory again for 2006, with the notable exception of Japan's, which had suffered a particularly steep fall since hitting its peak in April.
| 2005 close | 30 June close | Percent change | |
| S&P 500 | 1,248.29 | 1,270.20 | 1.8 |
| Nikkei 225 | 16,111.43 | 15,505.18 | -3.8 |
| FTSE 100 | 5,618.8 | 5,833.4 | 3.8 |
| DAX | 5,408.26 | 5,683.31 | 5.1 |
| CAC 40 | 4,715.23 | 4,965.96 | 5.3 |
| Hang Seng | 14,876.43 | 16,267.62 | 9.4 |
| Sensex | 9,397.93 | 10,609.25 | 12.9 |
All this looks relatively good for stock investors, but not everyone is jumping to buy stocks. In fact, the jump in stock prices on 29 June specifically elicited a warning from MarketWatch's Mark Hulbert: "The stock market's huge rally Thursday afternoon was a knee-jerk reaction that will get corrected as soon as investors seriously examine the rationales that were used to justify that rally."
It was a bold prediction, but the stock market duly obliged. The very next day, the S&P 500 fell, albeit marginally by 0.2 percent.
However, if Hulbert's reason for a correction is correct, there will probably be more declines to come.
As Hulbert wrote, the reason the market rallied was that the Federal Reserve, in raising interest rates by 25 basis points that day, had also signalled that its rate-hike cycle might soon come to an end. Hulbert noted that the stock market usually performs better when rates are lower than when they are higher.
However, he also pointed out that the expected end to rate hikes is likely to be accompanied by economic weakness. He quoted Jeffrey Hirsch of the Almanac Investor Newsletter as saying: "When the market rallies because the Fed says the economy is weakening you are in trouble."
Hulbert also cited research by James Stack, editor of the InvesTech Research Portfolio Strategy newsletter, which showed that the S&P 500 tended to fall within a year of the end of a rate-hiking campaign.
So if history repeats itself, there are more stock market declines to come.
Having said that, however, it is probably worthwhile asking how much of a factor the Federal Reserve's statement was in the rally. John Mauldin, president of Millennium Wave Advisors, LLC, pointed out in a commentary on 30 June that in the previous day's surge, much of it occurred before the Federal Reserve made its announcement. He suggested rather that "end of the quarter gamesmanship, with funds working to move their favorite stocks up", was also a factor.
Indeed, the S&P 500 had made its recent bottom on 13 June, about a fortnight before the interest-rate decision. Other markets around the world had also made bottoms around the same time. In other words, stock markets were already recovering from their recent falls before the latest Federal Reserve meeting.
Rather, perhaps the main significance of the Federal Reserve statement was that there was nothing in it to short-circuit a rally that was already developing.
Also an important consideration is the fact that the fall in global stock markets that started in May had been quite violent. When markets fall so far so fast, they usually take a breather at some point, when the initial panic selling dissipates and traders cover short sales. That is probably what is happening right now. It may or may not subsequently lead to a sustainable rally.
If the opinion of the newsletters cited by Hulbert is anything to go by though, it probably will not.
Some analysts point to the S&P 500's rise above its 200-day moving average as an indication that a long-term rally is underway, the theory being that when the index is above its average, it indicates that the trend is up, and when the index is below, it indicates that the trend is down. Unfortunately, this technique has not given reliable signals lately.
On 23 May, the S&P 500 closed below its 200-day moving average. The very next day, it closed above the average, and remained above the average until 7 June, when it again closed below the average. This time, it stayed below the average until the rally of 29 June. Despite the decline on 30 June, it remained above the 200-day moving average.
Does this mean that we have started on a new bull market? Perhaps, but going by that logic, the chart of the S&P 500 above would show that the US stock market has had about half a dozen bull markets and half a dozen bear markets in the past three years or so.
That sounds like a lot of bull to me.
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