How every new bull market has its own special shape

By Michael Gordon Published: June 30 2009 03:00 Last updated: June 30 2009 03:00 Since the lows of March of this year, the steady rise in equity markets and the contraction in credit spreads have brought cheer. The reasons for the bounce in listed asset prices since March lie in a combination of a deceleration in the fall of levels of economic activity and the availability of some very oversold price levels that had been caused by deleveraging. The end of that vicious downward cycle was always likely to be the catalyst for a decent rally, if not a new bull market. But a new bull market is almost always different from the last. Market leadership changes. This point has been absent from the rise in prices in recent months. The required change in market leadership is generally seen through geographic, sector, industry and size rotation. For example, the bull market of the second half of the 1990s was led by technology in the US. Such was the force of this leadership that the US market was able to rise in 1999 in spite of more stocks falling than rising during that year. That market died when the dotcom bubble burst in 2000. The bull market that arose from the ashes of the 2000-2002 bear market found leadership in Asia and the emerging economies, from a geographic perspective, and, commensurate with that, in the natural resources industries. Financials played their part, as they were able to feed off the bull market and lower interest rates, providing the leverage that was ultimately to engineer last year's collapse. Technology stocks were laggards. However, as pretty much every area of the markets registered gains, diversification seemed to lessen in importance and was harder to obtain for many portfolio investors. Moreover, as leveraged money found its way to the new destinations, diversification became "leversification" as leveraged investors chased the same assets and their performance became more homogeneous. Globalisation has many benefits, but the portability of investments through the opening of markets and lifting of exchange and ownership controls over the past 20 years meant money followed money, with freedom, focus and a velocity that had few precedents. Now, as confidence returns, we see the same thing, with the same leaders and laggards. It is the dollar or not. It is government bonds or equities and commodities - which have almost become fungible from an asset allocation perspective. The dollar and treasuries are funding non-dollar real asset markets, significantly in the emerging world. It is 2006 all over again, in the listed world. "ABD" is the cry - "anything but dollars". Money flows seem one way again, and if sentiment were to tick down, we would probably see the dollar and G7 government bonds do well. Everything else would fall. Such binary outcomes are not what diversified investors such as pension fund trustees need or desire. It is not a healthy situation. What is to be done? First, portfolio investors must realise that the nature and characteristics of the marginal investor are vital. From 2003 to 2007, many balanced fund investors and pension fund trustees took comfort in the fact that their portfolios were apparently diversified, across asset class, geography and industry. While giving the appearance of diversity based on long-term historical price series and their standard deviations, the reality was different. The marginal investors' rationale, time-frame and levels of leverage were key and remain so. Second, for those who seek diversification, the rule suggesting a spread of assets might no longer be relevant. The type of stress testing in place in banks could be equally appropriate for pension funds. Liquidity is also critical. As we saw during the crisis, many supposedly liquid markets seized up. The current market feels too much like the most recently deceased bull market for comfort. That has implications for price levels and correlations. Those concerned by risk matters need to be wary on both counts. The writer is a former chief investment officer at Fidelity International