Capitulation, or the Beginning of the End

A wild night on European and US bourses will put Australian investors’ nerves to the test today. A late bounce in US trading has futures indicating a RISE at the open today, despite shares closing firmly in the red after the rally.

A wild night on European and US bourses will put Australian investors’ nerves to the test today.  A late bounce in US trading has futures indicating a RISE at the open today, despite shares closing firmly in the red after the rally. Trading today is further complicated by index options expiry, lower commodity prices and the release of local housing and inflation expectations data.

A number of commentators are pointing to a further rout in oil prices as the catalyst for the fall. The logic is tenuous at best. Oil prices are falling because supply is increasing – not due to weakening demand. While this may have deflationary impacts, on balance lower input prices for companies are good for profits and the broader economy. The coincidence of falling oil and share prices suggests this is a sentiment rather than analysis driven sell down.

Investors may take comfort that major global indices have hit significant support levels. Further selling from this point would provide a signal to chartist that markets are going much lower. However, a bounce in the Dow, Nikkei and S&P 500 in the next session would attract technical based buying.

The most important question for markets is whether last night’s huge trading ranges and sharp turnaround represent a capitulation, or the beginning of a much deeper problem. Just as bull markets often end with “blow-off tops”, bear markets end with the last bulls capitulating, and cutting their positions. The other view is that the wild market behaviour is a sign of further instability to come. The next twenty four hours are crucial to the near and medium term outlook for markets.