A new year has breathed new life and new hope into equity markets.
But while vital credit conditions have eased and investors are rediscovering their appetite for risk, a wounded bear market remains lurking beneath the surface - and may lash out again unless the recent rally is backed up by sustained economic improvements.
"I'm encouraged and relieved ... [but]we are treating this as a bear market rally," said Vincent Delisle, market strategist at Scotia Capital Inc. in Montreal.
"We'll be waiting for better confirmation."
Toronto's S&P/TSX composite index gained 186.58 points yesterday to 9,472.09, marking the Canadian benchmark's sixth successive gain. The index has risen in 13 of the past 19 sessions.
Meanwhile, the U.S. market's S&P 500 index has risen in 19 of the past 30 sessions since hitting 11-year lows in November. Over that time, the S&P 500 has surged 24 per cent, while the S&P/TSX is up 22 per cent.
With markets deeply oversold, year-end selling for tax-loss purposes out of the way and large institutional investors rebalancing portfolios that had become top-heavy with safe-haven bonds, money is flowing back into equities and other asset classes.
That is all being fuelled by a loosening of the credit markets and a narrowing of bond yield spreads, signalling improved liquidity and an improving appetite for risk.
The VIX index, which tracks implied U.S. market volatility, has tumbled to 38, after peaking above 80 in November.
The Montreal Exchange's MVX index, which tracks S&P/TSX 60 implied volatility, last week dropped below 40 for the first time since late September, less than half its November peak.
The dramatic easing in implied volatility indicates that investors' view of risk has eased considerably, although it remains considerably elevated by historical standards.
"People are taking investments away from some of the really safe stuff and creeping back into equities," said Robert McWhirter, head of hedge fund firm Selective Asset Management in Toronto.
The rally has come even as some of the most dismal North American and global economic indicators rolled out over the past few weeks. Market strategists said that suggests the markets had already fully discounted the bleak economic picture that unravelled in December.
"The doomsday scenario had already been mostly priced into equities," Mr. Delisle said.
Helping Canadian equities has been the recovery in commodity prices, especially oil. The Reuters/Jefferies CRB commodity index has gained 16 per cent since early December, while crude oil in New York has jumped $15 (U.S.) a barrel since sinking below $33 in mid-December.
The S&P 500 turned a key corner for technical traders last week, when the index moved above its 50-day moving average. This week, the moving average itself ended a long-term decline and began to edge upward.
"From a technical standpoint, there seem to be a lot of stars aligning," Mr. McWhirter said.
Investors are also optimistic about the new U.S. administration set to take office this month, with a promised stimulus package in hand, as well as the upcoming Canadian federal budget.
David Rosenberg, chief North American economist at Merrill Lynch, noted that the biggest U.S. market gainers have been engineering and construction stocks - evidence that hopes surrounding the stimulus package are a key driver in the rally.
But while the recent gains have been welcomed by beleaguered market watchers, they say it is too early to declare an end to the bear market.
"No one would dare say it's for real, under the circumstances and what we've been through," said UBS Securities Canada chief strategist George Vasic.
Indeed, while conditions have improved from exceedingly poor levels, "normal" is still a long way off.
Standard & Poor's reported yesterday that despite a generally positive December, global equity markets lost nearly $17-trillion (U.S.) in value in 2008. While the MSCI World equity index is up 22 per cent from its November lows, that recovered less than one-third of the losses the index suffered in the three months prior.
The Toronto Stock Exchange was one of the few global markets that posted losses in December, bringing its losses for the year to $820-billion (Canadian). Despite gaining 14 per cent since Christmas, the S&P/TSX composite index is still trading at some of its lowest levels in four years.
Strategists said the deeply oversold conditions and improving tone could sustain the rally for a few more weeks, but its staying power beyond that will depend largely on the state of economic and credit conditions.
If the central bank and fiscal stimulus efforts aren't translating into economic gains, and if the credit market doesn't continue to improve from still strained levels, stocks may be in for another pullback.
"Investors are going to be reluctant to say 'this is the one,' " Mr. Vasic said. "They need to be able to believe that the worst-case scenario isn't just around the corner."
Mr. Rosenberg warned that the markets appear to be assuming that the Barack Obama administration's policies will trigger a quick turnaround in U.S. economic fortunes.
"We are left wondering what the market reaction will be when it becomes clearer that the recovery will require a lot more time," he wrote.
LEADING THE WAY IN 2009
| 1. | FNX Mining | +54% |
| 2. | First Quantum | +53% |
| 3. | Quadra Mining | +49% |
| 4. | Inmet Mining | +48% |
| 5. | Equinox Minerals | +47% |
| 6. | Ivanhoe Mines | +44% |
| 7. | Sherritt | +41% |
| 8. | Teck Cominco | +36% |
| 9. | Connacher Oil | +35% |
| 10. | Major Drilling | +33% |
Source: Bloomberg