3 Reasons I Think a Bull Market Rally Is Imminent

When I came to Wall Street in the mid 90s, one of my first jobs involved tracking changes in stock and bond prices and determining what these changes would mean for the firm's profitability. As prices fluctuated, I contemplated what caused the swing. My instincts told me there should be a level of certainty involved in a process that caused vast amounts of wealth to change hands on a daily basis, but I soon learned otherwise. Occasionally we can look to concrete facts as the basis for changes in asset values, but often nonspecific events, or noise, cause the price swings.

If prices are driven only by noise, we should expect markets to remain in broad trading ranges with no true direction. However, if prices are reacting to specific events, we are on the cusp of key changes that will affect stock prices well into the future. I believe we are on the cusp of such an event and that prices are set to move higher.

You might wonder how anyone can be bullish in such dire economic times. Here are my reasons:

• Non-confirmation - When global markets carved out lows in November 2008, the lows were synchronized. Since then, the Dow Transports and CAC 40 have broken to new lows, while the Dow Jones Industrial Average (Dow), S&P 500, NASDAQ, Wilshire 5000, FTSE 100, and DAX have not only refused to confirm these lows, but have rallied from the brief retest. This dichotomy raises the possibility that the worst of the market decline has passed and prices are set to move higher.
• Market Internals - Even as most markets have fallen 3 to 6% during 2009, the market internals look strong. VIX is falling, the percentage of NYSE stocks trading above their 50- and 200-day moving averages (MA) is increasing, and new highs are starting to outpace new lows. With the base of the market firming, all that is needed is strong investor demand to push prices materially higher.
• Financials Leading - The financial sector is the core of our economy. Until banks begin lending, any economic recovery will be short-lived. For the first time in months, we are beginning to see financials lead the broad market. If this trend continues, it is a strong sign that the market is going to turn bullish.

Even though each of these events points to higher stock prices, risks remain. Events that could stall the rally include:

• An inadequate Obama stimulus- Much hope has been placed in the ability of the federal government to reflate the economy. If the stimulus fails to become law (unlikely), or the recipients save their new funds rather than spend them (a real possibility), confidence will crash and stock prices will follow.
• The unraveling of the "Bad Bank" plan- A cornerstone of the financial rescue is the FDIC buying toxic assets from banks. Although purchasing these assets would unclog balance sheets, the main hurdle is price. If the FDIC pays too low a price, banks would be better suited holding the asset and retaining any upside surprise. If the FDIC's price is too high, taxpayers will be outraged that they are disadvantaged in favor of banks that caused the crisis.
• The unexpected- Over the last two years, the unexpected has destroyed wealth. Although we can never plan for the unknown, we must be prepared to react to that which comes our way.

Within the context of a bullish feeling existing alongside real risks, diligence remains essential. In my portfolios I am skewing my trades bullishly, but realize I must watch for warning signs. For over six months, I have stressed that we are in a long-term trading market that will reward those who are quick and punish those who are apathetic. For the moment, skew your trades to the long side, but be prepared to exit when the facts change. Doing so will allow you to stay one step ahead of a very treacherous market.

Comments

[Crocodilian:]

Unfortunately, all three of your negative "surprises" seem quite likely, if they're not already here:

<< * An inadequate Obama stimulus- Much hope has been placed in the ability of the federal government to reflate the economy. If the stimulus fails to become law (unlikely), or the recipients save their new funds rather than spend them (a real possibility), confidence will crash and stock prices will follow.>>

Seems highly likely. The Rs are lobbying heavily for the stimulus to be in the form of a tax cut, which will be disastrous. Borrowing will go up, but spending won't -- I know what I'll do with my tax cut, and spending ain't on the agenda. To be a stimulus, the money has to be spent, preferably on capital projects. . . to the extent that it isn't, it won't stimulate anything much. More Federal borrowing + more individual savings = a wash

<<The unraveling of the "Bad Bank" plan- A cornerstone of the financial rescue is the FDIC buying toxic assets from banks.>>

I'm not sure what the "Plan" is. Do you know what the plan is? I'd watch Secretary Paulson and marvel at the lack of anything other than panic-- how many explanations can you recall?

<<The unexpected- Over the last two years, the unexpected has destroyed wealth. Although we can never plan for the unknown unknowns, we must be prepared to react to that which comes our way.>>

We are living with events which financial statisticians told us wouldn't occur. Housing finance economists were certain that housing markets would never, in aggregate decline %10 year over year in all markets. . . but they have. At this point, though, its not the unexpected that's worrisome-- the expected is bad enough.

It is my expectation that the financial system is going to go through a lot more money before this is done. I can't see how the market goes up with a financial system filled with walking corpses.

Jan 29 08:14 AM

[perfessa:]

Bull market rally---this guy is nuts. We're entering a horrendus recession and an inflation that will dwarf all previous inflations. Stock and bond markets going south, way south.

Jan 29 08:14 AM

[Thoreau:]

Uh dude, you may be right but Roubini has not been wrong yet. Why don’t the accounting firms who audit the bankrupt financial institutions listen to Roubini? Roubini has been right about this whole mess going back to 2005 and made public his analysis, this is not a case of not being able to know the unknown. How can accounting firms like KPMG continue to issue fraudulent financials for Banks like Citi, the math is there for all to see.
…………………………………………………………...
Nouriel Roubini and Elisa Parisi-Capone of RGE Monitor release new estimates for expected loan losses and writedowns on U.S. originated securitizations:
• Loan losses on a total of $12.37 trillion unsecuritized loans are expected to reach $1.6 trillion. Of these, U.S. banks and brokers are expected to incur $1.1 trillion.
• Mark-to-market writedowns based on derivatives prices and cash bond indices on a further $10.84 trillion in securities reached about $2 trillion ($1.92 trillion.) About 40% of these securities (and losses) are held abroad according to flow-of-funds data. U.S. banks and broker dealers are assumed to incur a share of 30-35%, or $600-700 billion in securities writedowns.
• Total loan losses and securities writedowns on U.S. originated assets are expected to reach about $3.6 trillion. The U.S. banking sector is exposed to half of this figure, or $1.8 trillion (i.e. $1.1 trillion loan losses + $700bn writedowns.)
• FDIC-insured banks’ capitalization is $1.3 trillion as of Q3 2008; investment banks had $110bn in equity capital as of Q3 2008. Past recapitalization via TARP 1 funds of $230bn and private capital of $200bn still leaves the U.S. banking system borderline insolvent if our loss estimates materialize.
…………………………………………………………...

If Professor Roubini is correct and I fear he is, why don’t any of the accounting firms listen to him? What about starting with the accounting firms and perhaps, one of the worst offenders KPMG.

KPMG audits Citi, how can anyone trust their financial statements? Why does anyone even care what KPMG has to say? Why does anyone want to work at KPMG? KPMG audits a disproportionate percentage of financials yet totally missed the banking collapse. Exactly what is KPMG expert at and why would anyone listen to them after all their failed audits of failed institutions? Many as early as 2005 predicted the financial meltdown and the unsustainable lending pattern of the financials including Dr. Roubini of the Stern School of economics, why didn’t KPMG listen. If I were a partner or employee at KPMG I would be extremely concerned about all the pending lawsuits and potential criminal liability of KPMG. You know for a fact that Tim Flynn the CEO and Joe Loonan the head lawyer will not stand behind the partners as evidenced by the tax partners KPMG threw under the bus when the DOJ came a calling. In fact, Flynn, completely reneged on the former O’Kelley’s promise to support the tax partners (after he got brain cancer) and lied to the tax partners by pulling the carpet out from under the them by hiring Bennett and Holmes to not only lie about the tax partners to the DOJ but deny them legal fees for defense at the DOJ’s request. Loonan, Holmes and Flynn, totally screwed the tax partners and an email exists wherein Loonan specifically states that in the KPMG tax settlement with the DOJ he has no idea if any of the facts are correct but KPMG better sign or the DOJ will put them out of business and ends the email by saying: “freedom is just another word for nothing left to lose”. The point of course is those that run KPMG have no honor, are lying scum and if you are employed by KPMG and something bad happens, KPMG will do everything it can to ensure it survives at your expense. Of course something bad has happened, the banking collapse was a no brainer, predicted by many and most of the KPMG audits of the financials are riddled with fraud. The lawsuits and criminal investigations are coming, no doubt. All KPMG partners and employees should be very concerned as KPMG has no problem throwing them under the bus for a life of ass raping if it will save KPMG a nickel. Why any clients would accept advice or rely on KPMG for anything shows a total lack of due diligence and perhaps, negligence by those clients choosing to use KPMG. Of course, the last sentence does not apply to those clients that are actually consensually engaging in fraud with KPMG. The firm of KPMG has no honor or expertise in any matter just self interested thieves like Flynn, Holmes and Loonan attempting to make as much money as possible for themselves before the firm implodes. Many emails exist concerning KPMG’s malevolence and will be disseminated over time. Thoreau has a great quote, “no one can associate themselves with the U.S. Government without disgrace”, the same applies to KPMG, no one can associate themselves with KPMG without disgrace.

Jan 29 08:21 AM

[Schweizer:]

Yeah, S&P PE is now 25. Bear market lows are made at a PE of 9.

I'll wait.

Jan 29 08:23 AM

[The Good Ne...:]

Sean,

I strongly agree.

Lacking the unexpected, equities have no where to go but up from here.

Liquidity is being injected into the system at a rate never seen. As confidence builds, we'll continue to see activity like yesterday with markets blowing through resistance levels on the upside.

And as firms begin to ADD JOBS at unprecedented rates,
goodnewseconomsit.com/...
an eye to future quarters will only yield the commensurate earnings...

>For over six months, I have stressed that
>we are in a long-term trading market
>that will reward those who are quick
>and punish those who are apathetic.

Keep stressing this for any who will listen,
(some will, but many won't)
...for me this is the golden rule of business.

GNE
goodnewseconomist.com

Jan 29 08:31 AM

[Archman Inv...:]

Spoken like a true asset gatherer.

S & P 500, 25 year trend line puts the index at 750 as of today.

The farther is goes above that, the farther it has to fall once it reverts to that mean.

Traders who understand that, will keep making money in the years to come. Mom and Pop investors who who listen to asset gathering managers, will eventually get into the market, as always, at much higher levels, only to once again, lose a bundle.

If only we could just go to 750, and then have the index return 10% (div's included) for the next 2 decades, instead of the usual up 20%, down 8%, up 12%, down 40%., thanks to the hedge funds and Fed, manipulating the markets.

Wouldn't that be nice??

Jan 29 08:35 AM

[Lars39:]

Of course there will be a rally, but it will be quickly followed by a sell off as most investors don't expect a sustained rally. Bears rule this market, and probably will for the rest of 2009.

Jan 29 08:51 AM

[investor88:]

Good reasons for imminent bull but there are even stronger reasons for an imminent bear. Let the market lead us, on that we are agreed.

Jan 29 08:54 AM

[donzoab:]

The trendline here is irrefutable. The dow and s & p continue to set lower lows and lower highs.
9650 day of obama's election
9050 day of inauguration
8300 on this run??
We still have NOT tested the true low in 2002 or 7250. We will, be patient.

Jan 29 10:40 AM

[PROXIMO:]

I agree 100% with the tone of the article. The stock market goes up unless it doesn't.

Jan 29 05:43 PM

[sunnsea:]

Like past pumps by the Fed, the banks are taking some of the TARP money and day trading it making it look like there is the beginning of a rally. There's nothing other than that involved.

Jan 30 09:46 AM

[Urbane Gori...:]

Sign up for his weekly blog before you beat him up. His articles are very thoughtful and detailed, combining technicals, fundamentals and general market trends. Even if you don;t want to follow his advice, he really does produce very good work. You can't get the detail from this short work... jegan

Jan 30 01:37 PM

[y3115y:]

You saw a few evergreen trees in the winter but missed the whole forest that was in the mid of the winter. There is always a few bright spots, but don't forget to see the whole picture.

Jan 30 02:15 PM

[auto44:]

Huh!


On Jan 29 08:31 AM Good News Economist wrote:

> Sean,
>
> I strongly agree.
>
> Lacking the unexpected, equities have no where to go but up from
> here.
>
> Liquidity is being injected into the system at a rate never seen.
> As confidence builds, we'll continue to see activity like yesterday
> with markets blowing through resistance levels on the upside.
>
> And as firms begin to ADD JOBS at unprecedented rates,
> goodnewseconomsit.com/...
>
> an eye to future quarters will only yield the commensurate earnings...
>

Jan 30 03:08 PM

[ngwun:]

...no crap?

Jan 31 10:08 PM

[Rafael Grillo:]

The depth of the finacial and economic crisis is such that I don't envision a sustained bull market until well into 2010 or beyond. This is not your normal recession. The economy needs to correct years if not decades of excess. It needs to resettle at a level sustainable by true productive output, and even that needs to account for the re-payment of the gigantic debt that financed our excessive living standard of the last decades. That means dramatically lower real income for consumers and, correspondingly, far lower revenue for companies. The economic shockwaves are not over. Everyone is looking at the Government to bail the economy out, but the Government has not limitless resources. Taxes will have to increase, further dragging recovery. We can not borrow our way out of a crisis created by borrowing in excess. As much as it hurts, as an economy we're toast for the next decade. Yes, there will be bear rallies and you could still make money in those, but as a long-term generation of wealth, the stock market will be compromised for the years to come. If any, it will be a stock-pickers' market. Commiting to or paying atention to broad indexes will be foolish. What it pains me is that those who have been disciplined is saving and investing are the ones who will pay for the party, while the irresponsible people who lived large and accumulated credit card debt will simply be bailed out.

Feb 02 09:43 PM