IS IT STILL A BEAR MARKET RALLY?

August 24, 2009

............... But "distribution" processes can last for several months. In 2007, the first top occurred in July, which we called perfectly. The market corrected. Then there was a rally off of the bottom in August. The indices made slightly higher highs in October 2007. We caught that top within two days. As it turned out, it was the 5 year bull market top. But at that point, the majority of stocks did not make new highs, meaning they had been under "distribution."

In past issues we have enumerated all the terrible fundamentals for the global economies, the $50-$60 trillion Mt. Everest of debt denominated in dollars, the fact that the banking system currently has a much higher leverage than at the peak in 2007, the fact that corporate earnings and sales have plunged, etc. But the stock market keeps rising. So, we have to think, what could be the reason. Here are several possible reasons:

1.  In a low volume, summer trading market, it's easy to squeeze the early short sellers who are using good analysis and realize that stocks are much too expensive. This is the game of the big trading operations.

2.  It behooves trading firms like Goldman to lure people back into the markets, as that enables companies to issue more stock (secondary offerings), which Goldman underwrites. It also enables mergers & acquisitions, and all types of money raising efforts. Therefore, more risk taking helps their business.

4. The government wants to encourage a strong stock market. The "President's Working Group on the Financial Markets," (use google.com) established after the 1987 market crash, has the power to intervene whenever there is a strong decline. However, currently it may have expanded that authority to actually produce a market rally, all in the interests of "preserving orderly markets."

BOTTOMLINE:  If you agree with us that the greatest financial crisis and wealth destruction, at least since the Great Depression, and possibly in the history of the nation, cannot be resolved with an 8 month recession, than you will not be convince by the Wall Street hype that this is a new bull market.

By Bert Dohmen August 4, 2009

Expect:  Big Rebound in GDP to be followed by "Double-dip"

.......... However, investors must recognize that this period of "green shoots" and "rosy scenario" will be followed by another decline into recession in 2010.

What are the reasons for a relapse into recession next year? A multitude! But here are some of the important ones:

1.      Tax hikes on the producers of society, the people who start companies and create jobs. With the current policies coming out of Washington, an entrepreneur has to be extremely bored and dimwitted to start a new firm.

2.      If nationalized health care becomes a reality, the above is amplified.

3.      The "Cap and Trade" is a multi-trillion dollar tax on everyone for the benefit of a few. It's a result of the greatest hoax in the history of mankind, "global warming produced by man."

4.      The global crisis was caused by excessive debt. The bailouts have not reduced debt, but only shifted it, from the private sector to the public sector.

5.      The only deleveraging has been in the hedge fund sector. In many other sectors, including banks, leverage is now greater than before the near meltdown of 2008.

6.      There is no credit expansion, the type of credit that produces economic growth, such as Commercial & Industrial Loans. Without credit expansion, there is no sustainable recovery.

7.      Jobs, jobs, jobs. Without job creation, how long can any recovery last?

The most important thing for investors is to differentiate between the short-to-intermediate term and the long term. This is critical. Over the intermediate term, psychology, false perceptions, market manipulations, and talk in Washington determine the markets. Over the long term, reality prevails.

It takes two quarters of positive GDP growth to mark the "end of a recession." We may have that early next year. The surprise however may be that similar to the Japanese experience, the economy will drop right back into recession thereafter.  The tax hikes and the expiration of the Bush tax cuts will virtually assure that.  

In the meantime, the average person will be led to believe that the greatest global financial crisis in history is over, after only 18 months. The investor is being convinced that the crisis that almost caused a meltdown of the global financial system, destroyed well over $60 TRILLION in wealth, produced real estate crashes globally, reduced trade by 30-45%, virtually shut down the credit markets, is still curtailing credit for businesses, caused 30 million people in the U.S. to be unemployed or underemployed, and caused the demise of financial institutions which had survived every depression and crisis of the last 150 years, is now over.

How easy the recession was! Many people I know felt no pain at all. So now, I guess we can start borrowing, spending, and speculating again. After all, even a newsmagazine told us that the recession is over. But life is not that easy.

As investors, we must take it one step at a time. You must look at the charts in order to differentiate between hype in the media and reality. Currently, with the S&P 500 at 1000, the index is only 4.4% above the high of almost two months earlier. But looking at all euphoria in the media, one would think that this is a rip-roaring bull market.

Although the long term looks poor, the intermediate term looks more promising. The next years will be the years for traders, not the "buy and hold" investor. Visit our website.

STOCK MARKET: BEAR MARKET RALLY PHASE II

.........  The bulls tell you that banks have raised billions of dollars to shore up their capital. However, the money raised by banks was by way of "secondary" offerings, i.e. companies selling more of their stock. Most of these stock offerings were below market price, meaning that existing shareholders were diluted. Apparently, they didn't complain too much as survival was at stake. In other words, the firms had to offer a great bargain to attract the money. To me, that's like car dealers offering big discounts: they lose money on each car sold, but they hope to make it up later with the "servicing."

Most of the rally since early March, when we gave our "buy" signal on the exact day of the low, has been caused by expectations that the economy will recover this year. We said the strength of the rally would even surprise some of the bulls and could go into August of the year. It was simple: the compression in prices had gone to an extreme. It was like a spring compressed to the maximum. The rebound is mechanical, not fundamental.

The bulls now tell you that the markets are forecasting a recovery. But markets act on "expectations" which are often totally wrong. Take the bull market top in October of 2007. Were the expectations that the "subprime mortgage crisis" would not infect the markets correct? Did that last rally "predict" a great economy in 2008? The fact is that the markets are wrong about half of the time.

In June, we wrote that our indicators were signaling a market correction, we also wrote:  "we don't expect a big plunge in the market during the summer, but rather a lot of back and forth. The summer market is being driven by the "black boxes," i.e. computer trading."

These "black box programs" trade against the emotions of the average traders. They may change positions several or many times in a day. They don't care about economic statistics or fundamentals, except as a way to benefit by going against the traditional emotional response of the average trader. When traders buy based on some positive news item, these programs go against that response by shorting against the initial response. It's a fact that the emotional response fades out quickly and then the markets, sectors, indices, or stocks go back to the trendline.

We have been talking about 60% of the daily stock volume coming from these operations. Our respected colleague, John Mauldin, and his Wall Street contacts say it's closer to 70-80%. Wow! That's incredible. In other words, actual investment buying of stocks has virtually dried up. And so has liquidity. This doesn't happen in normal bear markets.

Much of the trading now is "high frequency." The "black boxes" try to make as little as 50 cents per share on a trade, but they do it a thousand times a day. I see it in my own trading every day and I am trying to exploit that to my advantage.

Read this again so that it sinks in. This market rally has nothing to do with fundamentals. In fact, our view is that it is once again an engineered rally which eventually will end in a big trap for all the bulls. On July 31 the S&P 500 index was only 4.3% above the May 7 level, almost 3 months prior. Yes, the euphoria in the financial media makes it seem as if this were a rip-roaring bull market. Enthusiasm is getting too frothy. Whenever that happens, it's good to take some chips off of the table.