The Bottom Is for Real, but a Pause Is Due

The stock market has rallied sharply since the middle of March, leaving a lot of bears wandering and wondering in the woods.

The chart shows that the Dow has rallied close to 2000 points, or nearly 30%, since the bottom on March 9. The chart also shows that the Dow has now reached the 200 day moving average (blue line). We think the market may pause here. One reason for this belief is the long sideways trading action from July 2008 through the middle of October 2008. This trading range left a lot of traders with significant losses as stocks collapsed in February. Human nature says those traders will become sellers as the market moves closer to Dow 9,000.

We believe this pause in the market's recent upward march will be temporary. Stocks will continue higher later in the summer as Wall Street earnings estimates begin to turn higher in recognition of an improving economy.

As you may remember, we said on March 20 that we believed forces were in place to produce a turn in stocks. We have reiterated that call three additional times since then. The bottom line on these calls was and is the undergirding and strengthening of the banks.

We believe the collapse in the market in February was caused by Treasury Secretary Timothy Geithner's February 10th speech that was supposed to answer all of our questions about how the government was going to rescue the banks. Mr. Geithner did not distinguish himself in that speech and questions began to fly about the possibility of "nationalizing" the banks. Bank nationalization fears were unleashed when Mr. Geithner announced that the banks would be subjected to rigorous stress tests.

Worries over nationalization of the banks combined with the realization that the US auto industry was bankrupt caused investors to "think the worst" and abandon stocks. Stocks finally found a bottom as the Administration repeatedly promised that they had no intentions of nationalizing the banks. Indeed, the Administration continued to champion the idea that the banks were in reasonably good shape but needed more capital, which they were willing to provide.

By late April, the results of the stress tests were announced and showed that only about half of the banks tested needed additional capital and none of them appeared to be close to a government takeover.

Stocks gained upward momentum as those banks who were cited as needing more capital were able to sell additional stock in the open market. This would have been impossible before the results of the stress tests.

Adding power to the run-up in stocks has been a string of economic news that can best be described as "less bad" than before. Few data show truly good numbers, but it is clear that the economy is starting to respond to the Fed's very low interest rates and numerous programs to aid homeowners.

The news will not show positive data for many months yet, but we believe the worst is behind us.

This blog is for information purposes only. Do not make buy and sell decisions based on this information. Please consult your own financial advisor regarding any issue discussed here.

Comments

[jeandit75:]

In April 1930, the S&P touched its 200-day moving average, following a 46.3% rise in the index price. Then, investors also felt the worst was behind them just before seeing the market collaps another 80% in the summer of 1932. The market moves of then look quite similar to today's, so as the economy. We still have a slight probability of going full swing into depression and that probability is not being discounted at present time. Of course, its human nature to refuse to see the reality when its so negative. In short, an index touching its 200-day average is completely meaningless. Its sad that someone as young as me has to mention it to a white hair investor like you.

Jun 03 07:28 AM

[jeandit75:]

In April 1930, the S&P touched its 200-day moving average, following a 46.3% rise in the index price. Then, investors also felt the worst was behind them just before seeing the market collaps another 80% in the summer of 1932. The market moves of then look quite similar to today's, so as the economy. We still have a slight probability of going full swing into depression and that probability is not being discounted at present time. Of course, its human nature to refuse to see the reality when its so negative. In short, an index touching its 200-day average is completely meaningless. Its sad that someone as young as me has to mention it to a white hair investor like you.

Jun 03 07:28 AM

[jeandit75:]

In April 1930, the S&P touched its 200-day moving average, following a 46.3% rise in the index price. Then, investors also felt the worst was behind them just before seeing the market collaps another 80% in the summer of 1932. The market moves of then look quite similar to today's, so as the economy. We still have a slight probability of going full swing into depression and that probability is not being discounted at present time. Of course, its human nature to refuse to see the reality when its so negative. In short, an index touching its 200-day average is completely meaningless. Its sad that someone as young as me has to mention it to a white hair investor like you.

Jun 03 07:28 AM

[jeandit75:]

In April 1930, the S&P touched its 200-day moving average, following a 46.3% rise in the index price. Then, investors also felt the worst was behind them just before seeing the market collaps another 80% in the summer of 1932. The market moves of then look quite similar to today's, so as the economy. We still have a slight probability of going full swing into depression and that probability is not being discounted at present time. Of course, its human nature to refuse to see the reality when its so negative. In short, an index touching its 200-day average is completely meaningless. Its sad that someone as young as me has to mention it to a white hair investor like you.

Jun 03 07:28 AM

[jeandit75:]

I have no idea how the previous post appeared 4 times. It must be some conspiracy against my bear posts. Is the PPT also manipulating financial blogs? LoL

Jun 03 07:52 AM

[Rising Divi...:]

I read every post and thought, my, there are a lot of people who have the same bearish view.

Thanks for your note. No telling in these days who is pulling strings.

Jun 03 10:02 AM

[jeandit75:]

Greg, you said it, a lot of people have a bearish because they are forward looking and not backward (i.e. superficial look at technicals and moving averages).
Anyway, I just wanted to give you another perspective where the reaching the 200-day moving average was actually not conclusive as to where the economy was heading. That's it.


On Jun 03 10:02 AM Greg Donaldson wrote:

> I read every post and thought, my, there are a lot of people who
> have the same bearish view.
>
> Thanks for your note. No telling in these days who is pulling strings.

Jun 03 10:45 AM

[Mad Hedge F...:]

Here, here! For me it’s déjà vu all over again. When I traded the Nikkei during the nineties, every market rally was capped by a predictable flood of new equity issuance by cash starved, undercapitalized Japanese banks. It sucked the life out of the market for a decade, confining it to a monotonous 14,000-20,000 range, until it finally dropped by half again after the dotcom bust. Sound familiar? This was while the Dow was going from 2,000 to 10,000. Now the tables are turned. Last month saw American banks soak the market with new equity on an unprecedented scale; Citibank (C) $58 billion, Bank of America (BAC) $25.9 billion, Morgan Stanley (MS) $6.8 billion, Goldman Sachs (GS) $5.8 billion, and JP Morgan (JPM) $5 billion. If the market edges higher, we will no doubt face more supply. I have no doubt that this will define the top end of a range in the Dow that we will have to live with for quite a long time. Volatilities will crash. Better to go trade China, Brazil, India, or any other country that has large cash surpluses and relatively healthy banks.

Jun 03 11:44 AM

[Fred Voetsch:]

"As you may remember, we said on March 20 that we believed forces were in place to produce a turn in stocks."

Two weeks late. I'm a bear (at least have been for nearly 2 years) and I called the turn before that. And you called for a bottom in house prices in mid-January and yet they continue to drop at an accelerated pace.

Luckily for you your articles only go back to the start of the year because I imagine you weren't one of those on top of things in 2007 or 2008.

"Adding power to the run-up in stocks has been a string of economic news that can best be described as "less bad" than before. Few data show truly good numbers, but it is clear that the economy is starting to respond to the Fed's very low interest rates and numerous programs to aid homeowners."

And what do you think will happen as earnings stagnate at these poor levels and our tax burden from the "stimulus" begins to weigh on consumers and business?

If inflation picks up what will happen to any recovery when interest rates rise to combat it?

How many times have you seen the stock market do well when interest rates have nowhere to go but up?

It's obvious companies have no plans to hire so what will happen when unemployment reaches 10%, 11%, 12% or higher?

What will the effect be of the Chrysler and GM Bankruptcy?

Jun 03 04:47 PM

[Alphameister:]

The first visit to the 200-day average from below is a time for caution since that average tends to offer resistance. Only after the price has rallied above the average and established a pattern of higher highs and higher lows above the average is the pattern solidly bullish. To be unequivocally bullish, the average should also turn upward.

Jun 03 05:59 PM

[Swashbuckler:]

Bank strength is due soley to highest level manipulation, IMO. Major rout will be in full swing by this Fall.

Jun 03 06:03 PM