Bear Market Rally Infused with a Shot of Inflation

Well we've finally got the bear market rally many of us have been waiting for, kicking into high gear. I know I don't have to remind you, dear reader, that most of the largest stock market rallies in history occurred during nasty bear markets.

To illustrate this point, check out this graph of the stock market crash during the Great Depression - and if you've been drinking Bernanke's "green shoots" Kool Aid, you may want to even print it out and tape this to your desk to help detox your system. No market ever goes straight up or straight down, so this rally was to be expected, perhaps even overdue.

click to enlarge

So where are we at now? Since a low of 666 on the S&P earlier this year, we closed Friday's trading at 929 - a gain of 40% in roughly two months!

Here's the interesting thing - market indicators are now screaming "overbought" - and have been for the past couple of weeks - yet the market's ascent continues, without a pullback...at least yet. My favorite short-term trader, Jeff Clark, was at least a little early on his call for a market downturn. So what gives?

One theory I've been noodling on for the past couple of weeks is that inflation may be starting to creep into the system already. And the first place that will be reflected will be in asset prices - particularly in commodity prices. Which we're starting to see already.

On Friday I spoke with our friends at Stansberry Research, and they seem to share similar sentiments. So the next few weeks will be very interesting to say the least.

How should you play this? Yesterday I sold about half of my stocks - I had held them throughout the entire crash, and decided not to look at the portfolio until we got a bear market rally - which we have now. You may want to do the same. Don't be too greedy - if you were offered these prices two months ago, would you have hit the "sell" button?

I'm trying to focus all of my investments around a few key themes, such as agricultural commodities, that I can monitor. I've realized that it only takes one good idea to make money investing - so why have a portfolio of 30-40+ different investments that you need to keep track of?

Big Picture Scenarios

So if we take a step back and look at the big picture - I think we're seeing these two theories as the dominant ones:

1. Green shoots - Things are getting less bad. We'll have a long, slow recovery. In the end, things will be OK. Good time to buy stocks, they are still undervalued. This seems to be the theory supported by the mainstream financial press and Bernanke. So that's enough for us to throw it out.
2. Inflation soon - Governments are printing money at an alarming rate. This will eventually result inflation once the money works its way into the system. Most of the smart investment minds I track seem to believe this.

My only problem with #2 is that it's too obvious. It is the universal contrarian viewpoint, and almost seems to be too widely shared. Just like how the dollar should have gone down last year, and interest rates should have risen...and what happened in reality? The exact opposite.

So if we try to "expect the unexpected" - what could happen now that few people are expecting?

1. Outright deflation that can't be stopped - a la Robert Prechter. He believes the DOW will eventually reach it's low below 1000 - now THAT'S a contrarian viewpoint.
2. Inflation right now - the horse is out of the barn, interest rates have bottomed and are on their way to the moon, commodity prices are already starting to move, and we're going to reach the "uh oh" inflation phase much sooner than expected.

Regular readers know that I'm starting to warm up to the possibility of #2, and will trade accordingly as long as the commodity charts continue to agree. I'm keeping an open mind to all of these scenarios, and will do my best to let the markets guide my actions, rather than being wed to and stubbornly trading on a preferred theory, which is usually a quick way to financial ruin.

Comments

[Moon Kil Woong:]

Once you sell your stock where do you store your assets if inflation is coming. the whole reason equities are rising is because they are fleeing long term bonds and have no good place to stick it to hedge against rising inflationary pressure.

I otherwise agree with the author's assessment. Inflation worries are rearing their head way too soon to make anyone feel very safe.

May 11 06:48 AM

[Brett Owens:]

@ Moon: Commodities, particularly agriculture, is where I'm planning to store my assets if/when things take off. I expect agriculture to do even better than gold - people still have to eat.

May 11 03:15 PM