LONDON: Forget about “Go Away in May”. Forget about losing steam. Investors are showing very few signs that the global stock market rally is about to end.

World stocks as measured by MSCI hit a low on March 9. At the time of writing they have risen as much as 45 percent since then.

Remarkably, this has not been a particularly volatile affair. The index — which is used by professional investors as their benchmark — has gained in 12 out of the past 13 weeks.

It is enough to give any self-respecting bear a headache.

There are nonetheless a few things that need to be looked at to understand exactly what this rally is — what is driving it, what will keep it going and, critically, what kind of commitment investors have to it.

First, it should be remembered that the rally is coming from a very low base, so every gain looks better than it actually is.

Between an all-time high in November 2007 and the March low, the MSCI index crashed 60 percent or some 257 points. In points terms, the index has now recovered less than a third of that.

So the post-March gain may well be a correction from an overshoot. That is, the collapse of Lehman Brothers last year, the descent of major economies into recession and general nerves about everything drove investors to sell too much.

By buying back in now, the argument goes, investors are simply correcting a mistake that they made.

A case could be made that this is evident from the fact that most of the gains have been in emerging markets, the stock sector most hurt in last year’s collapse.

From high to low, MSCI’s emerging market index fell 67 percent during the subprime-cum-credit-cum-economic crisis. In points terms, it has regained more than 38 percent of that loss.

Since a 2009 low in March, the emerging market index has gained 68 percent compared with 43 percent for the MSCI index that tracks only developed market stocks.

ECONOMY REDUX?

Conversely, the emphasis on emerging markets underlines the factor that has most been behind the rise in global stocks — a growing belief that the worst of the economic downturn is over and that growth will return in autumn.

If this were to be the case, emerging markets would be among the first to recover as a kind of alpha play, that is, those who suffer the most in a downturn gain the most in an upturn.

Some of this is being reflected on commodity markets, which have been booming, albeit, again, from a low point.

Oil, for example, has more than doubled in price since February, which can’t help but raise the outlook for important emerging market producer countries such as Russia, Mexico and Brazil.

nvestors, meanwhile, are said to have reached a stage where they are demanding real evidence of economic recovery to keep buying stocks rather than just seeking signs of a slowing down or levelling off of decline.

This may be the case — and there is no doubt that unexpectedly poor economic data has the potential to knock stock markets and others hard.

But investors are not acting that way. They are in one of those moods where they will look for the good in any report and trade accordingly. On Friday, the U.S. Commerce Department reported that the U.S. economy shrank 5.7 percent year-on-year in the first quarter. This was worse than market expectations.

But stocks rose anyway, lifted by data showing corporate profits were up as well as by other reports on Japanese factory output, British house prices and German retail sales.

Even the bankruptcy of U.S. icon General Motors was taken as eliminating uncertainty rather than flagging the extent of risks ahead for industry.

FLOWS NOT SLOW

The final issue is commitment, and here there is very little doubt.

Nearly all investors’ sentiment indicators are up and flow data shows no sign of institutional investors retrenching after their nearly three month rally.

State Street, which tracks the big money flows through its custodial ledger, says that risk appetite is robust. Cross-border flows into both developed and emerging markets are among the highest they have been in a decade.

It also notes that investors currently hold the biggest short position in the dollar since August 2007 and that flows are positively correlated with yield, which it says is a clear signal of risk-seeking among investors in FX markets.

Other surveys show similar things.

Reuters asset allocation polls last week showed equity holdings among leading investors across the world, but mainly in the United States and Britain, holding steady in May, a time when they were supposed to be easing back from their buying frenzy.

Fund tracker EPFR Global also detects continued appetite for the riskier asset. Fresh flows were seen last week into emerging market stocks, high yield bonds, emerging market bonds and commodity and energy sector funds.

All this means one thing: if the big boys and girls continue to play, the game will go on.

source: Economictimes

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