News analysis

Market rally or just a bull trap really?

Favourable factors put squeeze on oversold market but many uncertainties remain

Sentiment in the global financial markets appears to be shifting away from gloom and doom.

After experiencing one of the biggest sell-offs in years, riskier assets from stocks to crude oil have rallied sharply in the past two weeks. Fund flow data from Citi Investment Research shows that investors are piling into stocks again. For the week ended last Wednesday, they had poured about US$4.5 billion (S$6.2 billion) into United States equity funds.

International investors have also become more bullish on emerging markets during the same period, ploughing US$1.7 billion into funds that invest in them. This marked the second straight week of emerging market funds attracting a net inflow.

The increase in risk appetite has enabled widely watched market indices to rebound sharply. After tumbling as much as 11 per cent since the year began, US stocks, as measured by the S&P 500 Index, are now down less than 1 per cent for the year. There is a similar strong recovery on Singapore's Straits Times Index, which has almost regained all the ground it lost after falling by as much as 12 per cent at one point since Jan 1.

It begs the question: Is this rally for real or is it a trap luring the remaining bullish investors to their doom once share prices resume their downward trend again?

The global stock market rebound has been triggered by a number of favourable factors that have come together at the same time to put the squeeze on a very oversold market.

The first of these is the sharp recovery in energy prices, driven by hopes of cooperative action among major oil producers such as Saudi Arabia and Russia to curb output.

Brent crude has climbed to almost US$40 a barrel, up over 40 per cent from a 12-year intraday low hit on Jan 20. Now, considering that the world uses about 100 million barrels of oil daily, that price gain over the past month puts an extra US$1.1 billion a day into oil producers' pockets.

This in turn relieves the pressure on the sovereign wealth funds, whose sources of capital are mostly derived from hydrocarbons. The oil bounty means they are not being forced to further liquidate their vast equity holdings in liquid markets like Wall Street and Tokyo to finance their countries' spending.

But the likelihood of further rises in oil prices looks slim as Iran - which managed to get sanctions lifted in January - looks unlikely to agree to a production freeze. Any further increase in the crude price will also fuel an acceleration in shale oil activity in the US - and that is likely to act as a dampener, given the glut in global supplies.

The resurgence in global stock prices is also likely being driven by increased efforts by companies - especially those in the US - to buy back their own shares. As Bloomberg noted, companies that make up the S&P 500 Index stocks are poised to repurchase as much as US$165 billion in stocks for the March-to-June quarter - a buying spree that matches the record reached in 2007. Their purchases stand in stark contrast to the rampant selling by institutional funds that has pulled about US$40 billion from the US stock market since January. It is a trend that may be repeated here, as companies ramp up their stock purchases after the reporting season. There was $37.9 million in share buybacks last month and $80.9 million in January.

But as much of these share purchases is financed by bank borrowings, that may explain the fixation over every move the US central bank may make on interest rates.

Financial market conditions have improved in recent weeks, in part due to expectations that the Federal Reserve would hold off any further interest rate hike. A rate hike will make it costlier for firms to borrow to fund share buybacks. It will also boost appetite for the greenback and hurt the earnings of US firms with significant operations overseas. A US rate increase will also have an impact here as the Singapore dollar is tied to a basket of currencies, including the greenback. Thus, investors are likely to cling to every word put out by the Fed, as it concludes its two-day meeting today, for any indication of the direction it might take on interest rates.

That is not to mention the actions of other major central banks that may also have a bearing on global stock markets. The Bank of Japan's adoption of negative interest rates last month, for example, helped to unleash a sell-off in global bank shares.

Given the many uncertainties stalking the market, investors had better enjoy the calm while it lasts.

A version of this article appeared in the print edition of The Straits Times on March 16, 2016, with the headline 'Market rally or just a bull trap really?'. Subscribe