This Rally Is Sustainable: Halftime Report, Part 1

In early May, I wrote an article (“This Rally Is Sustainable,” available here) making an argument that the stock market rally might carry on for a while. I got soundly thrashed by commenters, with sentiment running heavily against the idea, although there were a few who bought it.

Now it is late July. We have reached the halfway point in the timeframe I defined for “sustainability.” So it is time for a halftime report.

Let us review. The day that article ran, the S&P 500 had been rallying since its close at 677 on March 9, and it finished on the day of publication at 884, up 31% since the rally began. It closed this past Friday, July 17, at 940, up another 6% since the first article. Altogether, the current rally is now more than four months old. During it, the S&P 500 has risen from 677 to 940, a 39% increase. The climb started fast in March, then slowed, went backward for awhile, then surged forward again last week. By month, the numbers are: +9% in March, +9% in April, +5% in May, 0% in June, and +2% so far in July (through last Friday). The largest drawdown since March 9 has been about 8%, which occurred over about four weeks from early June to early July.

So the rally has had a good run. Is it sustainable? Or is it “doomed,” a “sucker’s rally,” and a “dead cat bounce,” which it has been labeled with great confidence by many writers?

Framing the Issue

One thing which frankly drives me nuts in most investment articles is that practically nobody defines their time frames. Terms like bull market, bear market, primary trend, secondary trend, sucker’s rally, and dead-cat bounce are thrown around without ever being defined. Some writers seem to think that a bull market must last 10 years or more (secular bull market) in order to qualify at all. They and others dismiss the five-year, 101% rally from October, 2002 through October, 2007 as a non-event, just a sucker’s rally in the midst of a long bear period that began in 2000: “the bull market that never was.”

Sorry. I beg to differ. If an investor cannot profit from a five-year, 101% rise in the S&P 500, he or she is just not very good at investing. By any sensible definition, that was a bull market. But the important question is not whether the current rally is secular, primary, or a bull market. Rather, the key question is whether the rally is “investable.” That is, can an attentive, sensible investor, without frenetic trading, profit from it because of its length and magnitude?

I felt it important, in the first article, to define my time frame and magnitude. To do that, I used two definitions of “bull market” from the well-respected Ned Davis Research organization. By their first definition, we’ve already had a bull market. Under that definition, it is a bull market whenever there is a 30% rise in the stock market over a 50-calendar-day period. That had already happened at the time of my first article.

Ned Davis’ second definition of a bull market is a 13% rise over 155 calendar days. That has not happened yet. Just 129 days have passed since the rally began on March 10. The 155-day mark will be hit on August 12. But because the increase required under the second definition is just 13%, the market could go backward (to 765) and still satisfy the second definition. That would be minus 19% from where it stood at the open on Monday, July 20.

My focus was, and still is, about future sustainability of the rally, not definitions of bull markets. So for purposes of discussion, I created a definition of “sustained” by tacking Ned Davis’ second definition onto the point we were at when the first article was published. That yielded this framing of the issue: Will the S&P 500 reach 1050 by October 12, 2009?

That would certainly be a sustained, investable rally in most people’s minds. It would comprise a total increase of 55% since the March 9 low and a total duration of about seven months. Again, if you can’t make money under those conditions, you may not be very good at investing. From this point forward (July 20), it would require an additional 12% increase in the S&P 500 in a little under three months.

Making the Case

My arguments that the rally is sustainable have not changed much since the first article. In a nutshell, I made the case in May that historically, bull markets start about 6-7 months before the end of recessions, and backed it up by presenting evidence that the current recession is in its final months. I basically still feel that way. (Click here to see charts of the last nine recessions, with the ends of bear markets and beginnings of bull markets plotted out. The 6-7 month average lead time is clearly visible.)

I repeat emphatically that in talking about the market, I am not talking about the economy. They are different animals. The economy is still staggering through a deep and prolonged recession. Jamie Dimon, head of J. P. Morgan Chase, said last week, “We’re still obviously in a pretty big recession.” I agree with that. But the stock market historically moves several months ahead of the economy. So the question becomes, are we in the 2^nd inning or the 7^th inning of the recession?

The “unsustainable" camp argues that the current rally is clearly unsustainable, because the economy is still getting worse. But that is almost always true when the market turns up during a recession. Unemployment will almost assuredly continue to rise, perhaps to 10% or more. No question, the economy is not out of the woods until employment starts to improve. But employment has always been a lagging indicator. The charts of the last nine recessions referred to above show clearly that eight of them had bull markets that began not only prior to the end of the recession, but well before employment statistics turned positive.

Dr. Doom, Nouriel Roubini, stated last Thursday, "I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19 months into that recession. If as I predicted the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010." That would put us in the 7^th inning right now. (Note to flamers: This is not Roubini’s day-earlier statement that “The worst is behind us in terms of economic and fiscal conditions.” Some reports of that statement depicted Roubini as backing off from his earlier predictions about the recession. His Thursday statement is his refutation of those reports. He said that his Wednesday statement had been taken out of context.)

Roubini’s prediction is not very different from Federal Reserve Chairman Ben Bernanke’s statement in his March 15, 2009 60 Minutes interview, in which he said that he expects the recession to come to an end "probably this year." Again, that puts us in the 7^th inning now. Bernanke, of course, has been criticized repeatedly as part of the government cabal that is guilty of manipulating markets, falsifying government statistics, and conspiring with Wall Street and other fellow travelers to hoodwink the country into thinking our economy is better than it is. Roubini, on the other hand, has become something of a rock star among those who take a dim view of the country’s economic future. I find it interesting that Roubini and Bernanke—from opposite ends of the credibility spectrum for conspiracy theorists—both foresee an end to the recession around the end of 2009.

Part 2 >>

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