Why you shouldn't trust the stock market rally

Why you shouldn't trust the stock market rally
15 May 2012

WHAT fortunes did April hold for stock market investors? After establishing a new 52-week high on the first trading day of the month, stocks skidded.

Poor employment numbers and renewed worries about Europe – Spain this time – resulted in five straight down days.

These were more or less offset by four straight up days at the end of the month. The ISM manufacturing report was much better than expected and at one point the Dow Jones Industrial Average hit a four-year high.

The bottom line? The Dow ended one-and-a-half points from where it started.

US versus UK

The UK officially moved back into recession at the end of April, having posted two consecutive quarters of negative gross domestic product (GDP) growth.

This brings into focus the contrast between the two big Anglo-Saxon economies: while in the UK the level of economic activity is still some 4% below its pre-recession peak in real terms, the US economy had surpassed its pre-recession peak by the third quarter of last year. Its GDP growth is now 1.5%.

This is despite the many similarities the two economies share: both had huge financial crises followed by big bank bailouts and subsequent large budget deficits, facilitated by similarly low levels of interest rates.

Note of caution

However, there are two things not to like about the data coming from the US:

Fade into the finish: At one point the Dow was up 125 points. That was cut in half by the end of the day.

Not enough speculative fervour: Normally, when the market is this close to making new highs small caps lead the charge. This is an important sign that investors are willing to take on more risk through these more speculative stocks. Amazingly, on one day in April the Russell 2000 small cap index went form a 1.62% gain around noon all the way down to a 0.12% loss at the close.

Storm clouds

This rally is very suspect, so investors should be wary of trusting the upside potential at this stage. If US jobs news turns good and European debt woes continue to fade into the distance there’s room to be more positive.

However, storm clouds seem to be gathering over Spain as the risk continues to rise that the country will need financial support this year.

The Eurozone train is still heading towards buffers and the worst moments are still to come, so remain cautious at this juncture.

Pic credit: Sura Nualpradid/ FreeDigitalPhotos.net

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Independent Financial Advisor
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