Globally bullish or a bullish bubble?

It started in China. Base metals, equities and now iron ore have caught the bull market bug that started five days ago on the Shanghai Composite Index. The index was up nearly 6% from the close on Friday, capping five days of gains that has seen a 12.5% increase in the last five sessions.

Optimism has spread with global equity indices and the base metals sector all following suit. The driver is an article in the China Securities Times that said, ‘fostering a healthy bull market after the pandemic is now more important than ever’, as reported by Bloomberg.

Definition of healthy

After 30 years observing financial markets it is fair to say that stocks that going up in a straight line have either been subject to a hostile takeover or had greater than expected earnings. Generally, this is healthy for a stock

Indexes that go up in a straight line do not have the same support as an individual stock. You cannot takeover a composite, nor do their earnings all come out at once with greater than expected gains. This would suggest the Chinese retail market has come out in force and blind optimism is pushing the Shanghai Composite Index to extreme levels. The 21 period RSI has moved from 58 to 81 in a matter of days, technically it is overbought.

The reality is the retail market expects some form of action from the Chinese government in the form of a stimulus package or repo cut in the coming days. Otherwise buyers will be sitting there freshly long and potentially wrong, looking for a way to get out before the crowd catches on.

Iron ore follows suit

Iron ore has been struggling for direction since the 29th June with prices moving sideways. It had formed a base but has shown little desire to move up from it. However, the futures have started to rise on the back of the equity rally, volume is slightly elevated but not high, whilst aggregate open interest is not going up with price.

The DCE may have felt obliged to follow suit, but the rhetoric out if Vale is that prices will drop as their exports rise, meaning there is little evidence of a shift in sentiment at this point. This would suggest the retail market is sticking to equities and your average iron ore purchaser will want to see some hard evidence before jumping on the bull train.

With the WHO reporting an infection rate of over 200,000 a day at the weekend the markets will continue to be nervous. What looks like a bull today could be a bear tomorrow and if this happens there will be no doubt where this rally started.