Stocktake: inside financial markets

More than just a name change for Google What's in a name? About $30 billion in the case of Google/Alphabet, judging by last week's upbeat market reaction. This has puzzled many, who note the jump in Google's market value is greater than the market capitalisation of most S&P 500 stocks.

MarketWatch's Mark Hulbert compared it to the late 1990s, when stocks would soar after adding .com to their name. Hedge fund manager Doug Kass agreed, describing it as a "total non-event".

This misses the point. Last month, shares jumped after new chief financial officer Ruth Porat, a respected Wall Street veteran, promised Google would focus more on its core advertising business and become more efficient when it came to spending on its various speculative pet projects.

Last week’s announcement that the various businesses would be broken into separate companies under one holding company (Alphabet) is seen as delivering on that promise and increasing transparency.

Sceptics say investors are rewarding Google for belatedly adopting procedures that are the norm at most public companies.

One might equally argue investors had discounted Google shares due to transparency concerns; as these concerns are addressed, that discount is disappearing.

As Financial Times columnist John Gapper noted, investors "prefer a conglomerate called Alphabet to a company that had not made plain what it was". Last week's price action should be seen as a sigh of relief, not an irrational reaction to a mere name change. Does death cross spell doom? The US bull market has looked tired throughout 2015. Last week, the Dow Jones suffered a so-called death cross, its 50-day moving average falling below its 200-day average for the first time in four years. Should investors be spooked?

Bears point to timely death cross signals in 2000 and in January 2008 (or in the case of the Iseq, August 2007) which saved investors from savage market beatings.

Last week’s signal was the first since August 2011, “which was followed by a 1,300-point swing from high to low in the Dow”, adds the ever apocalyptic ZeroHedge blog. But markets actually soared 60 per cent in the three years following the 2011 crossover.

Similarly bad signals occurred in 2010, 2005 and 2004.

Indeed, Sundial Capital Research's Jason Goepfert notes contrarian traders have historically profited by buying after a death cross and selling when an upward crossover, or golden cross, occurs.

However, it’s not all positive; gains have historically been smaller than usual, while indices have exhibited much greater downside risk. Investors should not be spooked by this ominous-sounding indicator, but nor should they dismiss it as some old wives’ tale.

Investors are getting fussy Since early July, global investors have flocked to high-quality stocks and dumped low-quality firms. Historically, says Societe Generale's Andrew Lapthorne, that has been a sign a bear market is starting, with investors "positioning themselves exactly as you would expect if faced with an economic deceleration".

This represents a marked break in market behaviour. Expensive, low-quality stocks had been crushing cheap, high-quality names; money manager and Alpha Architect blogger Dr Wesley Gray recently noted the former have outperformed by 18 percentage points in 2015.

Now, investors are becoming more discriminating. Merrill Lynch notes companies that have beaten consensus earnings and sales estimates have outperformed by just 1 percentage point during the current earnings season; those that missed estimates have underperformed by more than 5 percentage points.

The biggest selloffs came from "crowded or momentum stocks" that disappointed, which "could be an early signal of risk to continued uptrends". Playing the trading range The market tone has been bearish in recent weeks. Last week's surprise Chinese devaluation didn't help sentiment, with even the perennially bullish Prof Jeremy Siegel warning a "very rough" correction may unfold in coming weeks.

Perhaps, but this remains a range-bound, choppy market, one which has never been up or down by more than 3.5 per cent at any stage in 2015.

The PastStat blog tested a trading strategy whereby one buys the index when it falls below its 20-day moving average and sells when it crosses back above it; it would have been profitable on 20 out of 20 occasions in 2015.

Betting against upward moves has been similarly profitable. This pattern may end at any stage.

For now, however, the short-term odds continue to favour a trading posture that is neither bullish nor bearish.