MARKETS SPECTATOR: Pullback poker

As world stock markets continue to defy gravity, we've got an interesting situation developing, which will be more prominent on the Australian market than others.

Given the depths of the bear market and the complete lack of confidence that ensued, a large proportion of money has missed out on the staggering performance of the last six months. Quite simply, they haven't believed in the rally and viewed it as just another bear market bounce before the doom and gloom descended once more.

Well, it looks like they've been caught out one too many times. They are now all finding themselves underperforming on both a relative and absolute basis as the bulls drive the market higher.

One thing that professionally managed money finds incredibly difficult to do is buy when prices are on the move or high, so to speak. They would much prefer to wait for a pullback and buy when other people are selling, which increases the liquidity and allows much better entry prices, especially when they're trying to invest millions upon millions.



Source: Bloomberg

However, what do you do when there are very few pullbacks and when they do occur, they're incredibly shallow?

As you can see in the above chart of the S&P/ASX 200 index, the market has gained 24 per cent since the lows in June 2012. Since then, the biggest pullback was in November when the market retreated 5.4 per cent after President Obama was re-elected and fiscal cliff headlines moved to the fore. While a few would have wisely entered, a lot did not as they simply couldn't bring themselves to look past the "off the cliff" headlines.

A 5.4 per cent pullback is not big at all and technically doesn't even register as a correction; you need a 10 per cent retreat for that. Of all the pullbacks since June last year, the average decline has been a meagre 2.94 per cent.

Now, we have an interesting situation. It's a bit of a standoff really. Everyone that hasn't been invested fully during the recent rally is eagerly awaiting a pullback so they can buy. The problem is that so is everybody else.

There is nothing more certain than a short term pullback (by the way, I don't think it is too far away either as everybody seems to be overly bullish now – herd mentality). However, when it comes it's going to be very interesting.

For example, let's assume that in three weeks' time the market has ground its way lower and finds itself down 4 per cent from its recent peak. Finally a pullback for everyone who missed out to buy.

Now comes the big question: Do we just jump back in and buy or do we wait for the market to pull back further.

My view is that because there is so much money waiting to buy that people will just jump the gun, so to speak and buy for fear of missing out on further upside. Naturally, this will put an artificial floor under the market and will be main reason why I think all pullbacks will be relatively shallow in the short to medium term.