In This Spoon-Fed Rally, Never Underestimate the Herd

An old friend of mine stopped by the office a few weeks ago and he unwittingly reinforced my complete confidence that you can still do very well in the markets. This is saying quite a bit, given the frustrating state of the markets where government decree drives nearly all of daily trading activity.

Now, he wasn’t overly bullish or bearish. He wasn’t betting big on a rally with banks. And he didn’t just make a huge score on some triple-leverage ETF or anything like that. He’s simply running his business and, in the midst of the worst economic downturn decades, it’s doing exceptionally well.

You see, my friend is a coin dealer. He sells gold and silver coins and bullion. But just the fact more people want more gold and silver bullion “insurance policies” during this time of uncertainty isn’t what has reinforced my faith in the markets. That’s actually a bit unnerving. It is how his sales were moving on a day-by-day basis which had relieved any angst I may have been feeling.

He told me:

“Ya know, when gold is at $800 or $900 an ounce, orders come in at a pretty slow rate. The volume is good, but it’s not overwhelming. When gold passed $1,000 an ounce, orders just flooded in.”

It doesn’t make any sense at all right? Wouldn’t you want to buy gold at $800 rather than $1,000 an ounce?

Well, as we’ve seen time and time again though, the herd doesn’t care. In this case, they couldn’t get enough gold at $1,000 an ounce and they have much less interest when it’s at $800.

Some things just never change. And the sooner we realize the most recent government intervention-inspired rally is what it is, we can get prepared for what is coming up next.

Was That the Bottom?

There’s no denying the recent rally has been a strong one. The 18% move over the past 10 days has been the biggest one since 1938. And there are untold number of folks claiming that was “the bottom” or a new bull market has emerged.

Quite frankly, no one knows for sure how far this one will go. But right now, a lot of indicators are still flashing “buy.”

Dr. Copper says the world economy is showing some signs of life. The price of copper has climbed more than 40% from its December lows and now sits at $1.77 per pound. Leading the way for copper consumption was China.

The housing market is getting a nice bounce as well. Although prices are still in the downtrend, activity is starting to pick up. The National Association of Realtors (NAR) reported yesterday existing home sales increased 5.1% in February. The NAR’s chief economist noted, “Distressed sales accounted for 40% to 45% of transactions in February.” The housing data just added fuel to the rally.

The thing is, we have only experienced a market like this a few times before and it’s all part of a quickly changing investor mindset.

A Spoon-Fed Rally

This rally has its foundation squarely in the hands of the government. As we’ve mentioned before, the government has a vested interest in ensuring the stock market stays up. This time around, they made a highly coordinated attack on the markets. Just take a look at what has happened over the past three weeks.

First, 60 Minutes was allowed to go “behind the scenes” with the FDIC as they took over a small bank. This was used to help explain how the FDIC works and how, if your bank is taken over, you shouldn’t be worried about getting your money. The FDIC is good at what it does.

Two days later, word leaks about the reinstallation of the “uptick rule” which prevents short-sellers from driving a stock artificially low. At the same time we get news Congress is investigating what would be the impact of relaxing the “mark to market” accounting rules on bank balance sheets.

Then, it's 60 Minutes at it again with a very rare interview of Fed Chairman Bernanke. Two days after that, Bernanke announces the latest Fed action to pump more than one trillion into the economy and push long-term interest rates significantly lower.

Then comes a weeklong PR campaign from President Obama to try and instill confidence in his economic team (they’ve clearly learned their lesson when it comes to Secretary Geithner speaking to the general public) right before the latest version of the Treasury’s “rescue plan” is detailed.

Through all that the government was spoon-feeding the markets more and more information about what the government’s plans are. And when we reached a point where any news is good news, the markets naturally recovered strongly.

Uncertainty Reigns Supreme

There is a lot to be said for this rally to continue all the way up to the G20 meeting next week. After all, that’s really what the government wants. So it can say we’re making all the right moves and can point to the stock market’s vote of confidence as evidence. I don’t know what they could possibly have planned next over the very short term.

But there are some days on the calendar where we can expect to get some information about the government plans and right now, any details are received exceptionally well by the markets.

For instance, the finalized government plans to rescue GM (GM) and Chrysler are due out by the end of the month. We can expect some big cash infusions given the recent bailout of the auto parts suppliers. (I sure hope Toyota (TM), Honda (HMC), and Nissan (NSANY) are paying their taxes so they can get redistributed to GM and Chrysler).

By the first of May, we’ll know which are the five “chosen” firms to participate in the Treasury’s low-risk, high reward Public-Private Investment Program (PPIP).

Also in the next few months, we’ll have a clearer picture of what new powers will be afforded the Treasury Secretary and the Fed Chairman to take apart a zombie bank. We also should have an idea of how much meddling Congress expects to do in all this. And we might get some sort of idea as to the extent of how much more regulation will be coming the way of the banks.

The Keys to Success

So, like I said before, the short-term movements of the market are anyone’s guess. All of the technical indicators are up and there are still trillions of dollars on the sidelines which have yet to flow into the market.

The latest version of the bank bailout plan was greeted with open arms, but there are huge lingering questions which will likely prevent a sustainable rally beyond another 20% to 30% from here.

For instance, when it comes to how successful the latest bank bailout plan will be, I think of the words of Milton Friedman. The Nobel laureate and free market advocate said:

“If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.”

There’s no reason to expect anything different from this bailout plan. Just think of how far we’ve come. It’s been half a year since this crisis really got rolling and we’ve just got the basic outline of a plan.

We still have budget issues in over 40 states. Real estate prices are still falling and there is so much inventory and “shadow” inventory (home owners and investors who are just waiting for a slightly better market) to work through. Unemployment is still on the rise. Overstretched consumers are paying down debt and getting their personal balance sheets fixed.

On top of all that, we’re facing one of the largest U.S. government deficits in history and a knockdown, drag-out struggle in Congress over the details of it. Along with this budget (even in its eventual watered-down form) comes higher taxes. Some of them will be levied directly against businesses. Others will be hidden ones like the “cap and trade.” And don’t forget about the very real possibility of an increase in the capital gains tax that was an option during the campaign.

Right now the markets are weighing the good, bad, and not-as-bad-as-we-thought. The not-as-bad-as-we-thought is winning.

As a trader, this is a strong rally. And it’s not one I’d be willing to bet against… yet. We still haven’t seen the “panic buying” from folks who are afraid they’ll never get to buy this low again which normally signals the end of the rally.

As an investor, I’m still sticking to a defined plan, buying stocks strategically, and trying not to get caught up in the day-to-day ups and downs. I always keep the herd in the back of my mind. They can’t get enough gold when it hits $1,000 yet won’t touch the stuff when it’s 20% cheaper.

Those are the real keys to investing successfully in a market like this.

Comments

[silver-bug:]

Well, 'spoon fed' seems a bit tame.. to me, it feels like this market is being fed intra-venously, with a couple of shots of some super stimulant hormones every other hour.

Mar 26 01:57 PM

[SeekingTruth:]

So far , the Government's actions are stimulative and palliative, offering great short term symptomatic relief.

Additionally, on the substance side, these actions are and were necessary to prevent a complete meltdown of a bogus based system and therefore are substantive in that regard.
I could see this halting a further steep slide in the markets, at least for awhile. But how it justifies a strong rally except on a limited short term technical basis is beyond me, but there it is (a la 1930's) for all to see and enjoy.
Together, this encourages and emboldens a substantial portion of the investing public, and the Institutional powers are more than happy to oblige them with their own strategies for juicing the markets.
The Government actions have made the Government the largest of all the "Wild Cards "in play today, and I fail to grasp how this would encourage anyone to the degree that I see on display today.

The Government actions are, however, "curative" of ABSOLUTELY NOTHING!

Until those curative actions are decided upon, and are being put in place on a swift and effective basis, our economy and Stock Market which reflects that economy shall continue to be held hostage to extreme jeopardy and more than the usual uncertainty.
If you like purely faith- based investing, this is your time and day. As for me, they are going to have to show me that this mess is not going to be sluffed over by the power and influence of Wall Street (again), before I re-invest a dime domestically.

The world stock market as my oyster, including commodities and foreign bonds, is a different story. Sort of protects against a collapse in the dollar also, a better than 50-50 bet, at least.
A very easy choice for me, considering the circumstances.

Mar 26 02:35 PM

[ValueInvestor:]

“Ya know, when gold is at $800 or $900 an ounce, orders come in at a pretty slow rate. The volume is good, but it’s not overwhelming. When gold passed $1,000 an ounce, orders just flooded in.”

Thats the typical man in the street mentality. Even though the saying goes Buy low sell high, the average person buys high and sells low.

Mar 26 02:38 PM

[dieuwer:]

Current P/E ratios must look bloated after a 20% rally off the lows.

Mar 26 03:01 PM

[The Sim:]

lol @ "mega rebound"

the stock market will put everyone back to work!

Mar 26 03:56 PM

[schlumpf:]

A good ´strong rally. This is the Ben - Geithner rally. Do you remember the Obama rally we had 3 - 4 month ago?

The money is waiting sidelines
The mutual fonds have to come back
The stocks are cheap
DOW 14.000
the money has to be invested (why? )
The goverment will fix it
the same bla bla.
greed eats brain

Mar 26 05:52 PM

[Hot Richard:]

As a trader, you should be in this market actively trading. I don't know of too many traders that should be in gold. I should remind you that the herd (by some definition) is actively buying this market.

However; my advice to investors is to have a majority of their assets in gold rather than equities.

Mar 26 07:30 PM

[drbob66:]

Don't fight the Fed!

Mar 26 07:40 PM

[William Cowie:]

If you think the market is being spoon fed, what will you call it when all those pinted dollars come chasing stocks? Force fed?

Mar 26 07:46 PM

[Roger Knights:]

Pension funds and insurance companies would be forced to reset if the market were below 7000 at the end of the quarter. I think that's a factor in the rally. In April, as the bad news keeps coming in, I think its gains will be erased.

Mar 26 08:39 PM

[mac.barron:]

Frankly, I'm running out of energy. The global economy hit the skids at the end of the summer and took a nosedive that was widely called "devastating" and "terrible." The consensus seemed to be that we had entered the kind of once-in-a-lifetime crash that leads to depression and changes everything.

Now, in early spring, a few days of the market moving up and, suddenly, people a coming out of the woodwork calling a bottom and talking about the start of the recovery.

The economy was fouled by the extension of silly amounts of credit and the foolish gambles that incompetent "experts" were permitted to take. The entire process is all the more frustrating because, rather than taking their lumps, the fools who precipitated this mess are being bailed out, just as they expected they would be. Moreover, the bailout is being done with fiat dollars that will have to be paid back at some point.

You cannot borrow your way out of the massive hole that prior borrowing dug. It's pretty simple, really.

A lot of people at S.A. do get it. They understand how to trade in a bear rally and not get caught in the trap. They see the value in the only asset class that a government can't create by fiat. They see clearly that a national economy based on paper games and not on a solid manufacturing base has no motive force.

There is a logic to all of this but it seems to escape a lot of people. I shouldn't care. I should be buying some ultrashort ETFs and letting those who rush in make me some more money. Still, I do care at least a little if others get whipsawed and I, like a lot of others here, will keep stating the case for caution and conservatism. Still, it's getting to feel like shoveling sand against the tide. Time will tell, as I always say, I'd love to be wrong and for this to be the start of a massive surge in the economy with full employment, a solid housing market and an emergent domestic clean energy sector but I just don't see the necessary groundwork getting done for any of that--just more foolish borrowing and kicking the can down the road.

Keep your powder dry.

Mar 26 08:54 PM

[Prince Step...:]

The bottom is in.


On Mar 26 11:34 AM mrmillergd wrote:

> This rally will definitely extend through next week as hedgies try
> to ensure that they "lose cash" prior to the end of the quarter.
> Otherwise those 2/20 fees look pretty steep to hold cash. I anticipate
> this thing tops out about a month after it starts.

Mar 26 09:30 PM

[Prince Step...:]

The bottom is in.

Mar 26 09:33 PM

[Bruce Pile:]

All this talk of the rally of 18% off the low tends to make you feel like a fool for not engaging aggressively in the falling knife catching game. But keep in mind that if you had bravely stepped in on the end-of-the-world dive in October and were lucky enough the have deployed an entire portfolio very near the tippy top bottom close then, you would still be nearly 10% down even after the recent rally. In the knife catching game, you have to be very careful which knife you're risking life and limb trying to catch.

Mar 26 10:38 PM

[Fighting Yoda:]

1. Agree with the author, everyone wants to buy at the top or when prices are high/rising and not at the bottom/falling. This is consumer psychology – there are bigger crowds in the mall before Christmas at full price. This herd mentality or predictably irrational or whatever else you want to call it happens all the time – this is simply a historical fact – that is why we have bubbles and busts.
2. Bottom is it in? I think you can’t get the bottom till you stop looking for it. Too many people calling it, too many people looking for it. Bottom will come when there is complete apathy – when you stop watching CNBC (or whatever you watch), stop reading, stop blogging. That is how I got to the bottom poet dot com – I realized few quarters – looking at my yahoo portfolio. I am getting there – discontinued my Barons subscription, may not renew WSJ, …
3. Fundamentals/economy- Lot more bad news yet to come – job losses, bankruptcies (MGM likely filing any moment now).
Consumer deleveraging- consumer has o bring his debt down from 100% of GDP to 50% - about 7 Trillion – will take more than several quarters.
Consumption – US consumer has to bring down consumption from 72% of GDP to 65% (historical average before current binge) – that is about a Trillion $ off every year from the GDP.
Commercial real estate – this bubble will burst next – lot more write downs and bankruptcies – General Growth, and the rest.
4. Current Rally: This is typical foolish on Wall Street – let’s have a party. Most commentators dub this a bear market rally, several opine we will revisit the lows – but at the same time suggest we buy into it. Unless you are a clever trader (there aren’t too many out there) – stay away from these rallies – any piece of bad news – job report due next week could (likely would) prick this bubble.

The economy will stabilize at a lower base, stock market will too. I am predicting we will revisit the lows and will go much lower – likely to 500 on S&P.

Mar 26 11:35 PM

[aarc:]

Technically speaking? We ain't done yet. More to come.

However, the same technical analysis is now giving a warning sign - OVERSOLD!

Stupid, saying oversold. Everybody knows that already.

Question is, how much oversold and what are the possible consequences of the different degrees of being in oversold conditions?

If you know Elliott Waves analysis, look at the monthly chart of Dow Jones. Dow Jones is defining an expanding flat that started year 2000 with the C wave of an A-B-C pattern starting it's usual way of imposing panic and pandemonium by dropping like a rock like no other C waves of other patterns such as that of a normal flat and the zigzag. The expanding flat has a quick and dirty price target of 4,750 as an initial guide to the possible final bottom of the expanding flat. 4,750 is quick and dirty target. The final bottom can only be ascertained with increasingly higher degree of certainly as the C wave unwinds and finally completes the 4th wave of the C wave which is projected to be by Sept2009. Unfortunately, finding the endpoint of the 4th wave is the hardest part of the C wave since most 4th waves are highly unpredictable.

Unpredictable or not; there are other ways of finding out potential high probability scenarios long before the 4th wave starts forming

One method is to measure how oversold the 3rd wave is as against the 1st wave. C wave goes into a 1-2-3-4-5 pattern.

For non-EW readers: The 1st wave is the run down from Oct 2007 to March 2008 with the lower low registering at Jan 2007 11,635 level. Use fibonacci price projection method if you have a professional charting software such as TradeStation or eSignal. Project the 1st wave at the top of the 2nd wave which is the top of May 2008 at 13,137.

You will see that the price projection indicated the "potential" 3rd wave has already gone more than 200% of the 1st wave. It is actually an extended run to the downside but not over-extended yet. Over-extended run is when it goes below 6,414 which is the 261.8% fibonacci level. Dow Jones was able to bounce these last 3 weeks from 6,468. Close but not quite.

That is not the important point.

In numerous cases of expanding flats that I have analyzed and measured; many of them were able to produce a truncated v-th of 3rd and/or THE 5th of the C wave when the iii-rd or 3rd goes much more than 200% run rate. Probability goes extremely high of a truncated 5th when the 3rd goes into over-extended run rate of more than 261.8%.

The most important point is that the bulls has now a chance to prevent a lower low from happening or being able to produce a truncated v-th and possible another truncated 5th which will produce a higher low above 6,468 of this month.

Also, a truncated 5th (which is a higher low 5th) has a special characteristic of resulting in massively fast and furious rallies - bear rally or not; that usually exceeds the usual run rate of the iv-th or of the 4th waves. A truncated v-th can even prevent the formation of the 4th wave and the 5th waves due to the massive strenght of the bear rally suddenly turning into a bull run.

How can this be accomplished?

A bear rally by Dow Jones straight above 8778 from the most recent 6468 low will give a small chance of producing a truncated v-th of the 3rd wave. A bear rally above 9412 will give DJ a fairly good chance of producing that extremely important higher low.

Dow Jones is capable of making a run up to 10,060 before the shorts start coming in with force. Most of them will not know the high probability of being able to only produce a truncated v-th (a higher low) rather than the lower low they so intent to make. This usually results in a massive short squeeze most shorts (and even well experienced bulls) never expected. Truncated waves don't happen so often that even some EW practitioners don't know of it's existence or how to know or to measure run rates that will produce such truncated waves.

Another technical parameter of extreme importance for the bulls is that the Dow Jones was able to recover the Oct2002 low of 7,197 after breaking down below that level last Feb of this year and was able to recover this month. A considerably high impact event most technically-oriented bearish traders are so afraid of being squeezed.

The bulls are now holding the ball for the first time since the Oct2008 low with a much higher chance of turning this bear rally into a bull run.

This is the short-term roadmap for the bulls. Anything can happen; but when things lined up according to expectations, the next stage of the roadmap can be laid out with considerably more confidence sorely lacking in this markets after more than 18 months of relentless sell-off.

Mar 27 01:31 PM

[PainfullyAware:]

The Rally Is Rebellion Against The Fatigue Of Being In A State Of Limbo. Unwinding Is On Hold In The Market And Banks; Yet The "Dark Clouds" Persist.

The Plunge Protection Team and The "Circus Ring Masters" Have Been Busy.

Pump It For The Quarter - Blow It Out On The Backside.

Mar 27 01:35 PM

[Aquater:]

Conspiracy theory has to be wild and juicy which the author's apparently is. It has to be self-serving and curve fitting which too it is. Entices the gullibles in. The author's final strategy to keep buying strong stocks has no element of benefit derived from the conspiracy theory. It has no connection with the spicy theory. What is the use of the theory, then, if you don't have the will or intellect to put it to your own advantage? It means you yourself don't really believe it! Pretty silly!

Mar 28 01:37 AM

[Audio Tactics:]

I agree with the author's premise that this rally is based mostly on rhetoric. It is true, however, that recent economic date is looking less dire. However, as some of the previous commentators have pointed out, the headwinds that lie ahead are still massive and we will probably see lower levels soon.

Mar 28 04:51 AM

[chleoku:]

Good insight. I agree that the rally is based on the herd effect. It's also very mis-leading for a lot of people when we look at the market trend in the last 3 weeks. I actually think the rally will be over soon:

www.wealthalchemist.co.../

Mar 28 07:03 AM