As the S&P 500 seems to be mired in the current resistance zone of 900-920, I continue to believe that we are in for a short-term rally to be followed by a decline which will test the November lows. In this, I agree with John Hussman’s view of the markets:
My guess, and it's only a guess, is that the general tenor of the market may remain tepidly positive for a few more weeks, but that we will ultimately observe another frightening leg down in the first part of next year – possibly to re-test the November lows, possibly to new lows, depending on the evolution of economic conditions. The problem isn't that stocks are expensive – they're not. The problem is that the U.S. economy will probably not see the beginnings of a recovery until the second half of 2009, and while we've seen a good deal of fear, the stock market tends to go through a great deal of sideways action after panics like we've observed. It's likely that stocks will trade in a very wide 25-35% range for months.
Here are some bullish signs that are supportive of a short-term rally:
- Bespoke reports that stocks owned by institutions are up big. This indicates that there is institutional sponsorship for this rally, which tends to be more powerful.
- Mebane Faber is expecting a good January. Faber concluded in a recent study that small stocks should enjoy a very good January after the dismal period we have seen in the markets.
Still just a bear market rally
Make no mistake about it, this is still only a bear market rally. While I believe that the market is undergoing a basing period, these kinds of basing periods can involve range-bound markets with explosive rallies and sharp declines. Here are some bearish indications for traders, which should banish any thoughts of sustainability when viewing this period of strength.
- There are still too many people looking for the market bottom. A couple of weeks ago, while watching CNBC as the market rallied off the November lows, I was struck by the number of people trying to call THE BOTTOM here. Add to that the rash of articles that came out about that time with the same sentiment (see examples here and here) and you can conclude that the market is still falling on a slope of hope.
- Earnings Season will start soon. 4Q earnings are likely to be horrendous and guidance will likely be no stroll in the park. What are the chances that we get another wave of negative surprises and a call for a double-dip recession?
- Disillusionment with Obama could set in quickly. Those looking for their brand of radical transformation from Barack Obama are likely to be disappointed. Obama’s cabinet appointments have shown that he is, at best, bent on evolutionary rather than revolutionary change. The finance posts were filled mostly by people who were prominent in the former Clinton Administration. The appointment of Gates at Defense is nothing more than a signal of “steady as she goes”. Soon after the Inauguration, any market expectations that the miracle worker St. Barack of Chicago would fix everything could very well come down to earth.
Enjoy the party, but don’t forget to leave before the coach turns itself back into a pumpkin.