Macroscope | Investors must remember bear market rallies always end in tears

The sudden surge in global equity markets since the middle of June must be recognised for what it is – a classic bear market rally, with weak foundations

For a sustainable turnaround in sentiment, at least four conditions need to be met and it is uncertain that this will happen

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Traders work on the New York Stock Exchange floor in Manhattan, on August 3. Photo: Reuters

Published: 3:30am, 5 Aug 2022Updated: 4:33am, 5 Aug 2022

Financial markets and the real economy often diverge, at times dramatically so. Investment strategists and commentators spend an inordinate amount of time trying to explain the disconnect between asset prices and economic data, which has been amplified by distortions in markets stemming from years of ultra-loose monetary policy.

While some divergences are more perplexing than others, the sudden surge in global equity markets since the middle of June ranks as one of the most baffling. In the first 5½ months of this year, the MSCI World Index, a gauge of stocks in developed economies, plunged 23 per cent. However, since June 17, it has shot up 9.7 per cent.

To be sure, the rebound has been driven by stocks in the United States, with the technology-heavy Nasdaq Composite Index up a striking 17.3 per cent. Yet, even shares in Europe, whose economy is more vulnerable because of the severity of the commodity shock caused by Russia’s invasion of Ukraine, have risen 8.7 per cent.

Moreover, it is not just stock markets that have bounced back. Government and corporate bonds, which were hammered by the dramatic increase in interest rates in most countries, have also enjoyed strong gains. Since June 14, the yield on the benchmark 10-year US Treasury bond has fallen from 3.5 per cent to 2.7 per cent, while spreads, or the risk premium, on US “junk” bonds have narrowed.

Even battered emerging market stocks, which face the double whammy of tighter US monetary policy and a sharp downturn in China, were flat last month.

That the unexpected improvement in sentiment across asset classes is a classic “bear market rally” – a short-lived rise in prices amid a longer-term decline – is beyond dispute. The question is whether there is any justification for a rally when the two major threats investors have been fretting about this year – stubbornly high inflation and the increasing likelihood of a policy-induced recession – continue to take their toll on the global economy.

.css-1m2rp1p{color:#34b8b5;}Macroscope | Investors must remember bear market rallies always end in tears

Macroscope | Investors must remember bear market rallies always end in tears