Plexus asks: What now for stock markets?

We have seen global developed stock markets, as represented by the MSCI World Index, rise by more than 75% from the March 2009 low to the mid-January 2010 high. Emerging markets, as represented by the MSCI Emerging Markets Index, put in an even more stellar performance with a rise of more than 116%.

Since the January highs, these two indices have declined by almost 7% and 10% respectively. Obviously, after such a huge recovery and the subsequent pull-back, investors are asking the question: “What now?” Dr Prieur du Plessis, chairman of the Plexus group, puts the current situation in perspective.

According to du Plessis, day-to-day movements of a stock market are random, and it is necessary to look at longer periods in order to try to determine the market trend. “One important tool market analysts use to establish a trend is the so-called moving average. The moving average of a stock market index or share price is the arithmetic average of the prices over a certain moving time frame, for example for a 50-day period from 1 September to 1 December and again from 2 September to 2 December, etc. A moving average smooths out the daily price fluctuations and helps us to see the emerging trend,” explains du Plessis.

“The time frame used for calculating the moving average can also tell you whether the trend is a short-term or a long-term one,” says du Plessis. A 50-day moving average is normally used to depict the short-term trend in the market and the 200-day moving average the long-term trend.”

Plexus Asset Management recently did an analysis to establish the trend of global stock markets based on the aforementioned different momentum measurement tools. The analysis involved calculating what percentage of markets are trading above and what percentage are trading below both their 50-day and 200-day moving averages. “We did this for both developed and emerging markets, plotting the developed markets’ moving averages against the MSCI World Index and emerging markets’ moving averages against the MSCI Emerging Markets Index,” says du Plessis.

When looking at the current situation it is evident that the long-term trend in global markets still depicts a bull market (see Graph A). “Looking at developed and emerging markets separately, the trend is very similar,” says du Plessis. “Over 80% of developed markets and over 90% of emerging markets are trading above their 200-day moving averages. This is in stark contrast with the period between October/November 2008 and February/March 2009, when none of the markets analysed were trading above their 200-day moving averages. This period represented an excellent buying opportunity for the long term,” says du Plessis.

“The shorter-term trend is more bearish, however, with less than 10% of the developed markets and less than 20% of emerging markets trading below their 50-day moving averages and close to levels that depict strong short-term buy signals,” says du Plessis. “Both developed and emerging markets have come off very high levels, with especially the developed markets looking close to bottoming out.”

According to du Plessis, an analysis of the South African market reveals a similar picture (see accompanying Graph B). “The percentage of South African equities trading above their 200-day moving average is just below 80%, indicating that the long-term bull market is still intact. The shorter-term trend indicator showing the percentage of equities trading above their 50-day moving average dipped to below 40%, but has subsequently recovered to the mid-50% level in just a few days,” says du Plessis.

Du Plessis warns that the 50-day moving average is a short-term trend indicator and this could mean the current bounce may be short-lived. “The long-term investor would be wise to exercise caution as markets are not cheap and there are still risks to the economic recovery. We could very well see further pull-backs or at least more volatility in the short term. Rather phase a lump sum into the market over the next few months,” he advises.