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Is the recovery in the ASX 200 a “dead cat” bounce?

The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is rallying for the second day after Tuesday’s bruising sell-off but don’t let this recovery fool you as I think it’s a dead cat bounce.

If you aren’t familiar with this feline market analogy, it’s used to describe a short unsustainable recovery before another market sell-off.

Right now, the ASX 200 is bouncing like a dead cat as the index is eking out a 0.3% gain in after lunch trade, but is up close to 1% if you include yesterday’s recovery. This means the index has now clawed back most of its losses after China imposed tit-for-tat tariffs against the US.

What’s driving the latest rebound?

Today’s improved sentiment was triggered by news that US President Donald Trump postponed plans to slap tariffs on auto imports from the European Union for six months and that the US was close to resolving its trade differences with Mexico and Canada on steel.

Most sectors were trading in the black with the Xero Limited (ASX: XRO) share price topping the ASX 200 leader board followed by the Lynas Corporation Ltd (ASX: LYC) share price and the Mayne Pharma Group Ltd (ASX: MYX) share price.

But I wouldn’t be betting that the market mayhem is over. If anything, I think we have not seen the worse of the sell-off and the market is at risk of falling much further from here in the coming weeks.

Euphoria to be short-lived

There are a few reasons for my pessimistic market view. The way the start to the confession season is unfolding is one key reason for the glass-half-empty view. Profit growth in most sectors is lacklustre.

This wouldn’t be a big issue if the ASX 200 was 10% lower than where it is today as the profit outlook doesn’t quite justify our market breaking above April’s high of 6,386 – at least not on the short-term.

Market bulls might point to today’s better than expected job creation figures but I don’t think these are enough to offset the gloom. If anything, the rise in the unemployment rate due to the higher participation rate has strengthened the argument for the Reserve Bank of Australia (RBA) to cut rates – and the RBA doesn’t cut rates on good economic news.

Meanwhile, China and the US look to be miles away from striking a deal to end the trade war. It’s good that Trump is avoiding picking trade fights with US allies but the recent market sell-off is solely due to US and China. Until the two biggest economies put aside their trade differences, its hard to see risk appetite improve significantly.

Foolish takeaway

Negotiations are complicated by the different political beliefs between capitalist driven America and socialist focused China. Throw in the fact that Trump views trade as a zero-sum game where he can’t win unless someone loses, and you can see why getting an agreement will be no easy or quick task.

Further, I am not sure if Trump can resolve his issues with the EU as it looks like he just kicked the can down the road by deferring higher taxes on auto imports.

The risks to the global economy aren’t abating despite last night’s headlines. ASX investors should brace for more volatility ahead!

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Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Xero. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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