Market's Reckless Rally: Don't Trust It

As expected, the S&P 500 surged another 4% in the last week, making things especially interesting as the nation prepared for the big banks' stress test results and a slew of mediocre earnings... More on that later.

First, here's what's going on in the markets right now:

click to enlarge

While the current market situation has been described as one sustained two-month rally, if you take a look at the chart above you can see that there have actually been two pretty distinct rally patterns going on: a gradual stair-step climb, and a more recent unchecked surge.

When coming out of a correction, it's healthy for the market to stop and start – like the stairs above. At each pullback, the market is essentially forming short-term resistance (a price level the market has trouble falling below), a lot like how a mountain climber continuously anchors himself into the face of a cliff.

What's less healthy is the unchecked rally that has followed it. It's inevitable for a climber (or the market) to slip every now and again, but with those anchors spread out every 20 or 30 points the damage is limited. When a climber tries to scale a face without pausing momentarily to hammer any anchors in place though, the chances of falling right to the ground are much worse. That's what's worrying about the market right now.

Maybe stocks will manage to reach the summit without stumbling again, but that's a big "maybe" when your portfolio's on the line. Last week, I talked about the 200-day moving average, a potential stumbling block that the market would have to pass-by in order to continue its climb. We're now just 40 points and change from that level, meaning that a 4.7% move in the market will test its mettle.

I'd recommend keeping a fairly close eye on your portfolio for the next week or so.

A "Stressful" Week

This week's big news item was that the bank stress test results came out Thursday. Regulators determined that the 10 biggest banks would need to raise $75 billion in capital in order to handle the contingency of a deeper recession – a number dwarfed by the $600 billion in potential bank losses estimated by the Fed for 2009 and 2010.

Worst on the list was Bank of America (NYSE: BAC), in need of $33.9 billion in tier 1 capital. About half of the banks tested were deemed deficient in capital under the Fed's "worst case scenario" tests, but I have an uneasy feeling that the banks in need of funds have a rich Uncle who's only too happy to shell out cash.

The market reacted by closing down 1.32%.

Saying Bye to EMCOR

Thursday, the Rhino Stock Report sold its position in EMCOR Group (NYSE: EME) for 42% gains. That makes EMCOR our fourth double-digit sale in 2009. It also means that the Rhino Stock Report's portfolio is up 17.46% since November, a period over which the S&P 500 is down 4.78%. In other words, we're beating the market by 22.24%.

Disclosure: The Rhino Stock Report sold EME on 5/7.

Comments

[Reserved Fo...:]

There are even more compelling reasons to be concerned here and they are sentiment readings. The sentiment has never had the markings of distrust on the bottom. Almost immediately, they shot up to bullish levels, very unusual for a major bottom. Right now they are on very bearish grounds-including the Rydex ratio of bulls-bears, the put-call ratio and the various polls most notably, the recent Barrons Big Money one, which now is more bullish than it was at the very top last year.

The same people who never warned of the dot-com and housing disasters are still in trying to recoup their losses. Caveat emptor.

May 08 08:49 AM

[Obi-Wan:]

Note: a mountain climber utilizes far more rationalization than the market does...............

May 08 09:08 AM

[winindthedust:]

By saying, "Don't trust the rally", you're saying that we shouldn't trust ourselves. WE are the rally.

Talk about emotional investing! The largest component, at the moment, like it or not, is sentiment. I believe going forward, there will be far fewer rainy day pullbacks, compared to positive surges. People in general are tired of being depressed, summer is here, people will travel, spend money on those postponed purchases, and generally turn off the dour news to spend a day at the beach with the family. This will all trickle into the market, supporting the rally. Pessimism investing will move the market higher, reinforcing the general good mood for the populace.

For myself, we just loaded up with a ton of work for the summer. We will have to actually hire more personnel. Those holding their money are starting to spend. Heck, my mother in law, who is the most frugal person I know, just went out and paid cash for a new vehicle! You guys looking at the charts, need to get out once in a while and smell the fresh flowers growing.

May 08 10:01 AM

[TheFounder:]

Looking back at past bear market, in all the cases I have seen, the market did not cross up the 200 day MA ,UNLESS a long term bull market has began. I may be incorrect but for that reason I am very confident the market will not cross it up in this rally. A great shorting opportunity between 925 and 975.

May 08 10:10 AM

[Steve in TN:]

Cetin for Secr. of the Treasury AND Fed Chairman!

May 08 02:13 PM

[cbc:]

The stress tests assumed a 8.9% unemployment rate for the year. We are already there folks, 7 months too early. The banks are going to need a lot more money. The market will crash again. Sooner is better than later. Then maybe we can start a rational, sustainable recovery.

May 08 03:40 PM

[corley10:]

The nasdaq has already crossed the 200 dma. (in response to the founder)

May 08 10:45 PM

[Erick Tippett:]

You folks sure cut each other up a lot ,"full of it".... It reminds me of
the chapter on the Monkey People in Rudyard Kipling's Jungle Book
"as the other animals would bury their dead off from the others, the
Monkey People would leave their dead out for all the others to see!"

Tsk! Tsk!

May 09 12:03 AM

[MarkitWacha:]

People have been ignoring the fundamentals. The reality is that we're about to go head to head again with high oil prices. That will be another negative shock, especially to the poor that have just taken salary cuts to be employed.

There's still at LEAST half a TRILLION dollars worth of [junk] bonds for the US Treasury to sell to support the BAD tax and spend habits of Congress (both parties). The foreign investors have been voting with something more powerful than votes -- dollars -- against this recklessness. With China dropping its investment in treasuries by 90% this quarter, I give the Congress 3 months worth of stepped up offerings before they drive the mortgage refinanciers out of business with a 10% 30-year mortgage (my prediction for August based on recent exponential trends).

Without those important fundamentals in place, the apparent forecasts and P/E ratios are way too rosy. This is a market for momentum hedge fund investors, not for individuals or pensions. Only the now-government-owned banks have access to a zero percent interest rate, not the companies.

I wouldn't call this a bona fide improvement until the short-term T-bills are paying ABOVE 0%.

May 09 01:12 PM