Small Vacuum of Time for a Substantial Short-Term Rally

For those of you following my articles at Seeking Alpha or on my blog, you know that I am fairly bearish on the market. In my government-TSP account (which has very few investment options), I have been hiding out in the G-Fund (like a Money Market Fund) since January 2008. Because of that, I have avoided most of the heavy losses in this market. In my IRA accounts and trading account, I have been mostly short the market, short banks, short real estate, and long gold (off and on). I'm filling you in on my personal account movements as it sets the tone for what I'm going to tell you in the next few paragraphs.

From all the articles/blogs I've read and the gurus I follow, I have felt for the last three months that this market would bottom out with the DJIA at around 5750-6250 and the S&P in a range of 575-625. I'm still not sure when I think this bottom will occur. I've said all along that I felt our economy (housing, jobs, consumer demand, etc) would not recover until 2011. The stock market tends to lead the economy by 6-9 months during normal recessions. Of course, this is NOT a normal recession, which makes timing a market bottom very difficult.

Based on these soft targets for a bottom, I started moving some retirement funds from the cash side to the long side when the Dow hit 7200 about two weeks ago. I started with a 30% position, leaving 70% in cash. Being realistic about my bottom-calling ability made me realize that I would miss a potential up move if I held out until I got the 6000 and 600 levels I was looking for. An initial 30% position would allow me the ability to make some money if the market did go higher, and also give me the flexibility to add more exposure if the market continued lower, as it did. As the market continued lower over the last two weeks, I moved my long position to 40%, then 55% at the market low. This leaves me with a 45% cash position now.

It had become very clear to me that this market was VERY oversold on a short-term basis. I feel like this market has a small vacuum of time to make a very substantial short term rally. All the bad news from the last earnings season is in the past. The market was VERY oversold. Tax refunds should be arriving soon which may find its way into the market. Americans have suddenly started to save instead of spend. The market is representing a short-term value.

For these reasons, I feel that the market could see a very nice rally between now and the beginning of the next round of earnings. If you haven't heard this before, you need to write this down and post it next to your trading desk. THE BIGGEST RALLIES HAPPEN DURING BEAR MARKETS. Not only are they big rallies, but they happen quickly. I'm going to put out another target for the market in this post. That target is an S&P 500 at a level of 875-925 by mid-April. I'm talking about a five-week move of about 35% (or about 20% higher from here).

Now for the bad news. Simultaneously with this move, you will see everyone jumping on the idea that the market bottom is in, the economy is surging, and all problems are now in the past. DO NOT BE FOOLED! This market is still very sick, and has a long way to go before our problems are behind us. The bottom line is that our economy has been fueled by easy credit and excessive debt since the 80's. Our economy is trying to correct itself back to normal. Unfortunately, our government is throwing money it doesn't have at the problem (our kids' future taxes). Congress is trying to tax and spend our way back into the easy-credit, high-debt lifestyle that we have become spoiled with. THIS WILL ONLY PROLONG THE PROBLEM! If we continue to nurse this problem with "band-aid" stimulus packages instead of letting Capitalism work like it was intended to, we will end up like Japan. (Expect 20-30 years of subpar growth).

I honestly feel like that is the path we are headed towards. Let's not forget, that prior to the First Great Depression (yes I did say the First), the DJIA topped out in 1929 at 386.1. It bottomed out 3 years later at 40.56 (about 90% lower). It took a full 25 years for the market to regain what it lost in 3 years. Although I do not think our market will lose 90% of its October 2007 peak, I would not be surprised if it takes more than a decade to see the DJIA back at the 14,000 level.

I'll end this rant with the thought that my original forecast of DJIA @ 6000 and S&P @ 600 may actually be a bit too high. I won't be lowering my forecast, but I won't be surprised if we blow through those levels a bit.

To sum up, expect another 20% to the upside over the next month, followed by more pain to the downside. It should go without saying that timing the market is a dangerous activity. For those who think it is impossible, you're not a trader. For those who study the market, keep a keen eye on money movements, and STUDY, STUDY, STUDY, you can make money in a market like this. Of course, I could be way off-base, but I'm willing to put my thoughts out there for your consumption, and yes, I am trading my accounts based on these predicted movements.

Comments

[Chezfrederick:]

Thanks for your views, but I think the market is too nervous and will turn in the short term at the first sign of negative news... When is the nest jobless report??? It is unlikely to keep moving up when it has been propped up by questionable announcements by banks, and meaningless pronouncements by regulators (Up-tick rules, M to M). Having said this I agree with you on the down leg and targets.

Mar 13 07:47 AM

[pacman1947:]

Matt,
You really are a bear hunter, my friend! (See seekingalpha.com/user/...) I also see that you are a former civil servant (as I am), which means that your heart is good. You follow your senses well. Asset allocations and discipline normally create a sound portfolio. I too am looking for a retracement of 30% or so, but I didn't expect it to come on phony news from market manipulators. You are correct. We are not well. We will recover only when the corruption is removed from the wound, or the limb is cut off.
Thanks for this thought-provoking wisdom.

Mar 13 08:32 AM

[expat in China:]

Very Nice Matt, I believe you may be exact!

what to sell on April 8 2009?

Mar 13 09:01 AM

[kelm:]

A very good article (didn't seem "rantish to me" at all).

I think this rally will run long enough to convince the most people that it is safe to get back in and especially those who have had their retirements decimated. Then it will reverse and annihilate what's left. We are in the part of the horror movie where it appears, to those who don't like to look to deeply, that the monster is dead - wrong.

We have a long way to go. I do question your statement about stocks leading an economic turn around by some months. That is conventional wisdom in normal times. I am not sure that will be the case this time.

Mar 13 09:14 AM

[Dave Wrixon:]

I think we have all been calling this wrong.

Stock valuations are normally based on earnings, but as they drop to the floor the lower bound is more asset based than earnings based.

The growing risk that foreign investors are not going to cover the US Government's borrowing requirements, makes it likely that the Fed will simply create money to cover the shortfall. Call it quantative easing if you like, or simply printing money, which whilst not entirely accurate better communicates the principle.

Such actions are going to trigger high inflation, which whilst bad for earnings can only be good for underlying asset values measured in depreciating dollars. Of coures the value of the Dow itself is in dollars so it can appear to be rising rapidly when infact it is merely treading water, whilst currencies realign.

The dollar has not really moved yet, but as we are often reminded the Dow is a leading indicator. It could be anticipating the debasement of the currency and moving to adjust for the increase in asset values in dollar terms.

Mar 13 11:10 AM

[ain't no fo...:]

I hope the author isn't saying that by needing capitalism to do its work we should let some huge banks fail. If so he should google CDS and read a bit about that little piece of unregulated, unfettered capitalistic insanity that has had the world on the edge of armageddon the past six months since the capitalists let LEH fail.

Because if he wants to see C go down the tubes to purge the capitalistic excesses of the past 25 years, his 6000 low on the Dow will be 6000 points too high.

Mar 13 12:04 PM

[joeboat:]

I went cash sept 07,I believe that the powers that be will
pull all sorts of shenanigans whenever S&P dips below 700
because insurance companies,pension funds,etc. are not ready to handle it politically. So without a natural fall
your bear rallies may not have the bang for the buck.Slow and drawn out is what is politically adroit to those on the in. Twice now Buffet has played the puppet and it is not to the invisible hand.

Mar 13 12:20 PM

[AndrewBaker:]

I agree entirely, and you have made me re-think this rally: I thought, and on my trading today, I hope, that the rally would fade away by Monday next (that is, if not today, then by close Monday). I wondered if there was pent-up cash being used (by mutual fund mangers?) or tax money maybe, but did not consider that there were enough people out there to keep throwing money at bad causes such that the market could rise by as much as another 20% into April. For me, for now, it's day-trading or sitting it out. Even shorts are risky at this time.

Mar 13 03:30 PM

[@TexasER:]

Andrew: Everything is always risky. Anyone who says otherwise is selling something.


On Mar 13 03:30 PM AndrewBaker wrote:

> Even shorts are risky at this
> time.

Mar 13 10:56 PM

[vaughn:]

Only traders could survive this market. All investors are assigned to the dust bean, done and over.

Wait, both shorts and longs have equal chance to be totally wiped out. Not even traders can survive!

Mar 14 03:03 AM

[Chezfrederick:]

It is amazing how little support there is in these comments to this and other posts. Who then is buying now?

Mar 15 10:05 AM

[1mania4u:]

wpdragon writes:

I hope the author isn't saying that by needing capitalism to do its work we should let some huge banks fail. If so he should google CDS and read a bit about that little piece of unregulated, unfettered capitalistic insanity that has had the world on the edge of armageddon the past six months since the capitalists let LEH fail.

Because if he wants to see C go down the tubes to purge the capitalistic excesses of the past 25 years, his 6000 low on the Dow will be 6000 points too high. Mar 13 12:04 PM | Link | Reply +30

<<

It is good to see someone who understands reality. CDS remains the elephant in the room that nobody wants to address, and it's not just an AIG problem, it's a systemic problem of irreversible complexity.

www.wilmott.com/blogs/...

Mar 16 10:16 PM