Dear Reader,

It felt like 2008 all over again!

Japanese markets fell, a stomach churning, 17.5% loss in just three trading sessions and the world looked grim. But that was then…

For now, it looks like optimism has returned to the markets after massive sell-offs of the last week. You can feel the sighs of relief as shell shocked investors pick through the wreckage of their portfolios.

Our local market (Top40 not All Share Index) bounced off the 27,000 and rallied hard. It managed to close at around 27,612 on the Friday before the long weekend and suddenly everything looked rosy again. But don’t be fooled!

You could call it a suckers rally. But whatever you do…

Don’t call it a recovery!

At least that’s what technical analyst Dominic Frisby says, and it could be good advice.

Read on to find out how you can tame the bear market…

From Dominic Frisby, in London

It’s taken the devastating combination of an escalating sovereign debt crisis in Europe, revolution across the Arab world and one of the most horrific natural disasters in modern history to finally take this two-year bull market down, but take it down it has.

We’ve seen nothing but inexorable, across-the-board selling as stock markets plummeted until finally we got some respite last Wednesday.

It’s felt like 2008 all over again. It doesn’t matter what you own, quality or not, everything has been sold. The baby has been thrown out with the bath water. Panic has set in.

This is one of those times, if ever there was one, to ‘keep your head when all about you are losing theirs’.

So let’s take a step back and think…
 

This sell-off started before the Japanese disaster

Historians may well look back and see it differently, but this sell-off began before the Japanese quakes. Emerging markets have been trending down since December last year. Despite new highs in gold and silver, the major gold stocks also made their highs late last year. The DAX, the FTSE, the Dow, the S&P 500 and the Nasdaq all peaked later, around 21 February.

Even uranium stocks, which are down by about 40% in barely two days (!) last week, were trending down a good three weeks before the earthquake hit. In fact only the CRB, the commodities index (which is heavily weighted to oil), was making new highs last week.

It has hugely exacerbated it, yes – it has turned it into something more serious. But the Japanese crisis wasn’t the initial cause of this sell-off.

In fact just last week, the day before the quake, I wrote: “It could be that this turn down (in the gold-silver ratio) is the beginning of the next phase of the financial crisis. It wouldn’t surprise me. It’s long-overdue and there are bearish signals all over the place. Senior gold stocks have been in a downtrend since late last year, even although gold has been rising. Emerging stock markets have been falling, although their Western counterparts have been rising. And a spike down in the gold-silver ratio often marks a major market turn”.

But this is all academic. We need to recognise the environment we’re now in. And the short of it is this: the bull market is over. We’re in a bear market now.

It’s time to sell the rallies

The first thing we can expect in the coming days is huge volatility. We’ve seen that to the downside already and the beginning of the first bounce. We’ll be able to learn a lot about what lies in store by the magnitude of this bounce.

Trade this volatility at your peril. Some will earn fortunes doing so, but many will not. Once the dust starts to settle, we can get a clearer idea of where things are trending.

Those that went defensive and started to take cash off the table as this bull market became more and more extended will be mightily relieved they did so. Those that didn’t should use rallies to build up cash for the opportunities that bear markets inevitably create.

For my part, this is what I see ahead.

The Nikkei has already been hit the hardest of any market. I hate to say it – and not everyone in the office agrees – but I think that’s likely to continue. It’s rallying as I write this, and should bounce from these oversold levels. There will also be some buying opportunities in individual stocks. But I’m afraid it looks doomed to eventually retest its 2009 lows around the 7,000 mark. Too many Japanese companies have been too badly beaten up by all of this.

But who knows? Maybe that will mark the final low at the end of Japan’s interminable bear market, just as in 2001 commodities retested their 1999 lows and finally ended their 20 years in the doldrums. Here we see a log chart of the Nikkei since 1988.

The Dow hasn’t been much better than the Nikkei

Many may look at the Dow over the last two years and think what a wonderful market it’s been, while they look at the Nikkei over the same period and think, ‘What a dog’. But this has largely been a result of the relative currency weakness. This week aside, the Nikkei’s recent performance isn’t as bad as it may seem.

If you take the Nikkei and measure it in US dollars, and take the Dow and measure it in Japanese yen, the performance has been virtually identical. This is shown in the chart below.

The strength of the Dow has been an illusion created by currency weakness.

The yen has been rallying as stocks are liquidated and cash pours into the area. This might well continue for as long as the stock market declines. Then these two may well turn together, perhaps as soon as early summer, as the spending and inevitable money-printing continues. (I bet the Japanese government will wish they hadn’t spent as much these last 20 years and got into so much debt, when they didn’t really need to).

For now, the Japanese must enter a period of mourning. And our thoughts and prayers should be with them as they do so. But once they start that rebuilding process, they will do so with great persistence and energy. And they’re going to have to import a lot of iron, a lot of copper, a lot of cement, a lot of energy. The Daily Telegraph says this “tragedy is expected to become the costliest natural disaster in history, with the repair bill likely to top £100 billion”.

So as we emerge from this panic, and the dust settles, commodities will likely resume their secular bull market, while stock markets and currencies continue to meander.

Until next time…

Dominic Frisby