Wall of Worry over Rally Begins to Tower

As doubt grows about the sustainability of the current rally and the strength in the financials, the possibility of another bottom increases. Our colleagues are fond of saying, as the proverbial “wall of worry” grows, the longer it remains, the better its chances of being right.

And we seem to only be adding support to this theory.

We recently discussed how the Bank Stress Tests could be the only thing big enough to cause another market rout, but we keep stumbling upon newer and even scarier drivers of a changeover.

As the banks rush to get rid of their “scarlet letters,” namely T.A.R.P, they may be getting rid of one shackle and adding another. Getting rid of government funds may not be the smartest thing.

The potential exists for the “other shoe to drop.” And by shoe we mean the crashing of the commercial real estate markets. It’s not as far-fetched as it sounds, and if the bankruptcy filing from General Growth Properties (NYSE: GGP) is any indication of the direction things could take, then we could have some serious problems on our hands.

If you look at the current numbers of this rally, we haven’t reached or come close to breaking out of the highs that the S&P (.INX) reached in January. No doubt that we’re not going to see 1500 or even 1200 any time soon in the index, but failure to push back to 1000 can’t be a good sign.

Comments

[Fighting Yoda:]

Nobody cares for the stress test - it is a complete farce. The test will be described after the results, to suit the results. Who knows how many lies will be included.

The basic problem is credibility, at this point non one trusts anyone - investors don't trust corporates, corporates don't trust the Govt. The rally is a sucker rally simple based on false hope, when there is no reason for hope - all economic data is getting worse and no end in sight - job loss numbers will again be 600K+.

Apr 19 04:58 AM

[CautiousInv...:]

One scenario that would bring the market to its knees would be if Treasury had insufficient funds to cover the capital shortfall as determined by the stress tests. Treasury would have to go back to an angry Congress.

Longer-term, Treasury's massive borrowing requirements could weigh on the markets with the distinct possibility of higher interest rates.

Apr 19 08:18 AM

[Steve0:]

"The crashing of the commercial real estate markets" This risk is way over stated by the doom and gloom crew. Commercial real estate will exhibit typical recession activity that will work its way through the market with little effect on stock prices.

The next month or so will show us whose crystal ball is correct. If we test the lows the armageddon folks will have the trend. If we retrace 10% from the current rally the bulls will run the table and we are back to a fairly normal market well worth investing your hard earned dollars in. Valuations, low debt rollover risk, a firming economy and tight stops are a play for pay.

Apr 19 09:38 AM

[Reserved Fo...:]

If a "wall of worry" includes a dramatic drop in the VIX, an extremely high call-put ratio, an unbelieveable .74 in the Rydex bull-bear ratio, an Investors Intelligence survey that now sports as many bulls as there were when the stock market was almost 35% higher, then the definition should be changed.

Apr 19 10:29 AM

[William Cowie:]

As I mentioned in another comment, we have to consider one additional factor which clearly is distorting the normal ebb and flow of the stock market: PPIP is handing taxpayer dollars to banks as profits, which they don't have to repay. We're already seen "surprising" earnings at the banks as a result. These inflated earnings are pushing up prices of banks stocks. Many are Dow components. As their prices go up, the Dow goes up, as well as the entire Financial sector. This kicks in automated program buying, which pushes up the Dow even further. This in turns is now beginning to suck in individual investors, directly and through mutual funds and ETFs.

Yes, there is a wall of worry. The question still open is whether our tax dollars at work are bigger and stronger than that wall. I, for one, would feel much more comfortable if we cap the PPIP program and let nature run its course. If these banks are crowing about how they don't need aid, let's cut PPIP first and see what tune they sing. If they can still repay TARP, great. My guess is they will grow very quiet very quickly. And the markets will begin to respond more rationally than now.

Apr 19 11:43 AM

[Crude Oil T...:]

Fighting Yoda is right and the market is always right. The market knows the Stress Test is a farce, everyone will pass. Big deal. If problems emerge though, welcome retest of 797 or lower.

Apr 19 11:52 AM

[cameroni:]

Well I do agree with you William,

There is a bit of game playing taking place with Tarp money, earnings reports and market expectations as the Financials are concerned. What I see is a very good opportunity to short them in the very near future. There is not even a debate in my mind that the Dow is set for another tumble. The failure of GM and Chrysler this quarter (million plus jobs on the line) could certainly trigger a major event but there are so many other bad news stories that collectively tied together this month will see us heading into another downward correction. The current bouyancy in the markets is based more on hope and habit than real optimism and faith of a turnaround. Virtually all indicators continue their down-trends with only opportunistic investing on global stock markets showing signs of life. You would be a fool to go long on anything now. We are in fact at or near a turning point and the markets can be expected to begin another decline. How severe will really all depend on the bad news we already expect (employment numbers, inflation changes, GDP, housing starts, bankruptcies etc) and the bad news we do not expect. The odds favor the bigger trend now though. I would not rule out a precipitous and sudden decline at this stage and frankly it would not take much of a sell-off to start a cascading event that will bring markets back into sync with what is actually taking place. We are overvalued again relative to the greater economy. A correction is imminent.

Cam

Apr 19 12:20 PM

[TheFounder:]

For me the key level is the 200 day MA, a very simple but powerful and reliable indicator of strength. Currently at 970.

Looking back al ALL bear markets, there was never a recovery without crossing the 200 day MA early on in the rally.

That will not happen here as we are still a long way from there with plenty of opportunities to lose strength and momentum before we even get there.

Apr 19 12:25 PM

[bbowen7:]

It is hard to blame the PPIP - it hasn't started. If you mean the TARP money that went to AIG to be recycled to the major investment banks to cover losses at who-knows-what discount, now that's a problem.

Apr 19 01:03 PM

[Alphameister:]

For the short run, it's become too easy to scale that "wall of worry," suggesting the imminence of a short-term pullback. But there is so much cash on the sidelines looking for an opportunity to buy into a market advance that increasingly looks durable that I'd expect the correction to be limited to 5% to 8%.

Apr 19 02:47 PM

[MGA_1:]

You know, if sub prime were the only problem, the economy *might* begin to recover fairly soon, but well, that looks to be not the case. Coming soon, commercial real estate defaults on a grand scale and Alt-A/Option Arm about as large as sub prime. Pull out the heavy storm gear !

Apr 19 05:57 PM

[ksmithdc:]

Interesting read, thanks.

Apr 19 08:25 PM