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Buy the bear market rally

Created:
13 October 2008
Written by:
Simon Thompson

The late British financier Sir John Templeton once said: "To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward." I have been following that advice in the past week, because although I don't think the bear market is over, I do believe the current down leg is nearly over.

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The reason I think that is because risk aversion has reached record and unsustainable levels. The indicators I use include Wall Street’s gauge of fear, the Vix; the advance:decline trading volume ratio on New York Stock Exchange; euro/yen exchange rate; TED Spread (Get Ready to Buy, 6 October 2008), the iTraxx Europe index, which tracks the cost of insuring investment grade corporate debt against default (Jaws of Death, 8 September 2008); and US five-year swap spreads in the US corporate bond market.

Make no mistake, we could be in for a powerful rally, because the speed and scale of the market's retreat over the past couple of weeks has been breathtaking. However, I must stress that any countertrend rally is likely to end the same way as all the others in this 16 month bear market. The fact remains that the contagion spreading from the financial crisis into the real economy has a long, long way to run.

Why? Because returns on equity - corporate profits - have yet to revert to their long-term averages, as they have done in every other bear market and because more carnage is likely in the bond markets. Buying into countertrend rallies is a trading strategy, not a long-term investment.

MORE FROM SIMON...

This is a summary of an article that appears on the IC website today, and in this Friday's issue of Investors Chronicle.

To read the full article, and discover what trading instruments Simon is using to play the expected counter-trend rally, you will need to be an IC Advantage subscriber.

Take a no-obligation trial subscription to IC Advantage.

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