Dead cat bounce or real rally? The market’s up: what’s next?

The last two years has been a two speed market.

Larger companies – aka the ASX 300 – have benefited from a massive flow of funds off risk into index strategies, namely in ETFs and superannuation.

This large increase in funds has become a self-fulfilling prophecy.

1. Go into low fee, index-hugging strategies to follow the market;
2. More investors put money in, which forces more buying in a fixed number of companies;
3. This pushes prices up for those, increasing the return of the strategy;
4. Which encourages more people to buy in and hug the index;
5. Which creates more buying, and so on.

The result has been the top end of town has done really, really well. Which is a global phenomenon. Just take a look at how the ASX200 has performed over the last five years:

Now, you’re either in the index or out of it. And if you’re out of it then you have less buyers combined with constant sellers: you have not had a good 24 months...

A couple of months ago we showed how the smallest of the listed companies were down more than 50% on average – there has been a lot of blood on the street.

This divergence has been combined with where we are in the cycle.

Lion Selection Group have a great clock that they issue and is increasingly becoming the gospel of the market. You can see here we are in the acquisition/M&A phase, where there are a lot of tired companies, with good assets, are getting taken out. These are usually being folded into bigger companies who can then, collectively, raise and deploy more capital than each can individually.

As a side effect, this is highlighting the price disparity between the larger companies and the smaller ones. Combined with a more “on risk” appetite, you would expect the lower end of the market to start coming back.

And so when we looked at the September + October data to see what this looks like across the market, that is exactly what is happening right now, with both September and October lifting.

This is a relatively large swing in a small period of time. Given the (1) relatively low share price that these companies have and (2) an illiquid market which responds strongly to new interest, micro caps and nano caps may be in for a fast recovery. Of course, this may also simply be a dead cat bounce.

But depending on where you sit on this interpretation of the bounce, here are two lessons for every listed company that is reading this article:

1. For larger companies looking to take advantage of this:
   1. Use your balance sheet.
      Now is the time to use your balance sheet to be soaking up micro caps. Either invest and take a big chunk of equity, buy key projects and provide cash, or take over the whole business.
   2. Stay visible.
      With a market that is potentially moving to a more speculative mindset, it is important to ensure that shares in your company don't become the capital to fund said speculation. It is important to remind your shareholders that you're a better business than you were 12 months ago and you'll be a better business 12 months from now, so their money doesn't need to go anywhere else.
2. For smaller companies looking to the future:
   1. Get ready for growth.
      If the market really is bouncing what does that mean? Ask yourself what would you do if your share price in 6 months is (1) the same, or (2) 50% higher? What would that mean for you? What could you do?
   2. Take advantage of this period.
      It has been a very tough time. If things keep trending up, then the macro environment is in your favour. People will be happier, more risk on, and willing to listen. As the market moves up people will have wins and look for their next one. Get yourself into a position to reap the harvest of a growing market.