Don’t be fooled by this sharemarket rally – there’s bad news to come: Gottliebsen

A series of events over the last few days have lead me to believe that the wonderful rally we have seen in Australian shares is overdone. It is increasingly looking to me like a “dead cat bounce”, although that’s clearly a big call given the weight of mon

A series of events over the last few days have lead me to believe that the wonderful rally we have seen in Australian shares is overdone. It is increasingly looking to me like a “dead cat bounce”, although that’s clearly a big call given the weight of money that came in behind our stocks and the value they presented at the bottom of the market.

Why has the market gone too far? Let me give you four reasons. There will be many others.

– A string of companies need to raise equity. Listed property trusts will be leading the charge to raise equity while the market is higher than it has been. However, banks and others won’t be far behind. Only the quick ones will get the money they need. Once institutions have subscribed to equity issues at a discount to the market, their buying power is eroded and they will get scared.

– There is a lot of bad news to come. Property values are going to come down. Worse still, a large number of companies are encountering difficult trading conditions. We are seeing this in the US and it was a key reason for the fall on Wall Street last night.

– We are going to have high interest rates for a long time. It may be well into 2009 before the first relief is given. At best it will be late 2008. As I have explained several times, the Reserve Bank wants to keep a lid on housing so that there is capacity to construct the large mineral projects and infrastructure. That means we will have high rates for an extended period, although from time to time there will be small reductions. Yet in this environment, high interest rates will not be a great instrument to lower inflation, as it is linked to oil prices and imports. For example, the Chinese are taking advantage of the high Australian dollar to raise the price of textiles, clothing and other goods by more than they are lifting American prices. Having captured the market, the Chinese are boosting prices and exporting their inflation.

– Oil has been falling, partly reflecting the contraction of demand. I think we will see a short term contraction of demand in a number of resource areas although in the longer term the outlook for resources is good because of the difficulty of raising supply. More importantly in the short term, the hedge funds have very long positions in oil, copper and other commodities and when they get scared they will dump them. We are vulnerable to big short term price falls –the reverse of what happened in listed property trusts, when the hedge funds that held huge short positions in our trusts started to cover and propelled the rise.

A bear market does not suddenly move into a bull phase but is characterised by periodic strong rallies. This is one of them.

This article first appeared on Business Spectator