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Three Phases of the Rally to Watch Out For: Strategist

There are three key periods of the current stock market rally, Graham Neilson, chief investment strategist, Cairn Capital, told CNBC Wednesday.

The rally since the start of the year has been driven by a return to risk assets, as markets absorbed the impact of monetary easing by the European Central Bank . Major indices including the S&P 500 and the FTSE 100 have risen, but analysts are divided on whether the rally will continue, and how it will progress.

“There are three phases to go through,” Neilson said.

He described the first as a “technical rally” from an oversold position.

“The technical aspect of the market becomes slightly stretched. If you look at credit spreads in the major indices, they are getting to that point,” he said.

The second happens when investors change their “allocation decisions.”

“You need allocation decisions by investors to be much more pro the market. I think we are slightly behind this at the moment and need to get on it or in front of it,” he said.

The final phase happens when bullish assumptions start to become more vulnerable.

“Economic growth expectations, probably outside of Europe or even within it outside the periphery, start to go up again, yields on major bond markets look pretty vulnerable and have to go higher to create that balance sheet pinch, commodity prices go higher and a general level of complacency starts to build. We’re not there yet,” Neilson said.

He added: “Until we get that, we’re not vulnerable to a proper sell-off. We’re vulnerable to corrections, but not sell-offs right now.”

One reason investors are concerned is that 2010’s rally was followed by the losses of 2011.

Neilson warned that the rally will “definitely be more vulnerable” by the end of 2012.

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