The Rally Really Was Sustainable

Note: The predecessors to this article are:

• “This Rally Is Sustainable” (May 13, 2009)
• “This Rally Is Sustainable: Halftime Report” (July 22, 2009)

In the two articles cited above, I put forth the proposition that the S&P 500 could hit 1050 by October 12, 2009. The first article described how I reached that target and date: I simply tacked together two “bull markets” as defined by the widely respected Ned Davis Research.

On the day the first article appeared, the S&P closed at 884. (The rally actually began on March 10 from a closing price of 677 the previous day.) The second article, the “halftime report,” demonstrated that the market was more-or-less on pace to reach the 1050 target value by the target date, and reiterated that I thought that the necessary conditions were still in place to make that achievable.

The first article, in May, produced a hail of criticism from commenters. The very idea that the rally might continue, and indeed exceed 50% in six or seven months, was considered preposterous by most. If anything, the majority view was that the market was on the verge of an imminent crash.

One commenter wrote,

Until [earnings] turn we should see PE valuation declines which will make the rally unsustainable.

Another wrote,

I think to be long here is insane.

And another:

Sorry, but this ‘rally’ is 50% propaganda, and 50% Plunge Protection Team. It sounds like you could use a large dose of REALITY.

At the end of the first article, I disclosed that I was cautiously buying into the rally. That brought this comment:

His disclosure tells you what he really thinks! Just another momo player trying to get YOU to be the next sucker.

The reasoning behind the proposition was simple. It was based on two observations that led to a logical conclusion. First, historically the market often begins going up several months before the end of a recession. It had happened in eight of the last nine recessions, as shown by charts that appeared in the article. I merely suggested that this recession might produce the same pattern. The reason the market does this is that it anticipates the future, and if market participants on balance believe that the recession is ending, they respond by buying stocks.

Second, there were signs all over the place that the recession was, in fact, ending. I listed seven such “green shoots” in my article. I also supplemented the main line of reasoning with other supportive data, including an assessment that the market was somewhat undervalued, and a simple analysis of technical trends.

By July 22, the time of the second article, the S&P 500 had risen to 954, up 8% since the first article and 41% since the beginning of the rally. In the “halftime” article I reviewed the landscape, decided it looked pretty much the same, and reiterated: S&P 1050 by October 12. I disclosed that my cautious re-entry into the market was continuing.

The criticism was more muted, but still in the majority. Examples include:

Please post your positions, I am trading against all of them.

And also:

Yeah, looks sustainable to me too- all you need is enough greater fools…. Anyone who puts money into this rigged casino just isn't paying attention. But that is what Government Sucks is counting on.

There was a little support too:

Thanks for daring to post an opinion that probably has 99% disagreement on this site and in every investment letter in my inbox.

The rally continued. It did come close to failing from a technical standpoint. Between mid-May and mid-June, according to every technical analyst that I read, a “perfect” head-and-shoulders pattern was formed, and they were unanimous in predicting that the market would plunge imminently. It didn’t happen. Instead, the market went a little sideways and down into July, hitting a short-term low of 879 on July 10.

But then we had a big 2.6% gain on July 13, and it has been pretty steadily upward since then, with of course some typical daily noise mixed in. On a monthly basis, the rally has been almost monotonous: +9% in March, +9% in April, +5% in May, flat in June, +7% in July, +3% in August, and +3% so far in September.

On a weekly basis, the market has been up in 19 out of 28 weeks since the rally began, with three weeks about flat.

If you define “correction” as a decline of 10% in a bull rally, there has been no correction throughout this entire rally. Many predicted that when traders got back from vacation in September, the rally would end, and sure enough, on September 1, the market dropped a little over 2%. But that didn’t last, and the market resumed its upward march within a couple of days.

Yesterday, September 15, it closed at a level that seemed impossible to so many: 1053. That is a 56% increase from the closing low on March 9, and a 19% increase from the close the day my first article appeared in May.

Where to from here? I would still make the same basic case for a continuation of the rally: This is a stock market rally in anticipation of the end of the recession. As long as what I call the “net news flow” continues to suggest that various economic fundamentals are getting less-worse, and that some have reached inflection points and are getting better, I think that the rally can continue.

I am making no predictions as to ultimate value and time-frame. In the free newsletter that supports my web site, I maintain a Timing Outlook that attempts to look forward about two to four weeks. Right now it is flashing green, as it has been for practically the entire rally.

I am not unaware of the strong counter-arguments against the continuation of this rally. In a nutshell, these arguments boil down to this: The rally has occurred despite negative fundamentals. The market is far over-extended and due for a correction or crash. Negative fundamentals supporting this position include continued high and growing unemployment; little money for consumers to spend; deleveraging across the business and consumer worlds; foreclosures continuing far down the road; a time-bomb in commercial real estate; and low volume and overvaluations in the market.

There is widespread disdain for government policy, and to the extent it is conceded that government policy helped pull the financial system back from an abyss, it is stated that the so-called green shoots are just the result of unsustainable government spending. Many proclaim the inevitability of a double-dip recession that will be disastrous for the markets.

All of this may come to pass. But these factors have been in place throughout the rally. Clearly, since March 9, the market has rejected them. My suggestion is that, to the extent you have purchased into the rally, or may be thinking of doing so now, you protect your positions with hedges or tight sell-stops. I cautiously invested into this rally beginning in April, going from 100% cash to 100% invested in small increments. From the beginning, I have used 8% sell-stops as a simple risk management technique against the chance that I was wrong. No sell-stop ever got hit.

Disclosure: Long SPY, QQQQ, and IBM based on the reasoning here. Also long about 15 dividend stocks based on a different strategy not impacted by the reasoning here.

Comments

[malach hamo...:]

we'll see

Sep 16 06:37 AM

[malach hamo...:]

said the Zenmaster

Sep 16 06:37 AM

[thiazole:]

Great article and kudos for making money when so many others sat on the sidelines and criticized. A very important point that this article makes is that you USUALLY have to go against the current to make money (and even though we all cognitively understand this, very few have the courage to practice it). If everyone understood was what going to happen after March, the market would have shot up almost instantly - sellers wouldn't have sold at such a low price and buyers would have been willing to pay more. It is only in the ignorance of others that opportunities show themselves.

Sep 16 09:55 AM

[YoYoMama:]

David Moenning of Incredible Charts is usually spot-on in analyzing where the market could go from here. The current prediction is up to S&P 1200 - 1300.

My eye is on the door, and I'm formulating some exit strategies now. But if this holds true, we are in for another minimum 10% more gains, and possibly more than 20%. I only require another 10% from here to double my IRA value from the March lows. It's been quite a ride.

Since we haven't yet fully unwound the toxic assets from our financial system, I eyeballing my financially-related holdings with great suspicion. But internationally, the world will continue to get bigger, and we will continue to require energy (oil, nat. gas, coal, alternatives) to fuel the growth, so my international and energy holdings may remain the only holdings I keep once the market threatens to break trend. All these holdings pay dividends, so even if they go underwater until the next bull, I will be rewarded.

Sep 16 10:33 AM

[Tom Armistead:]

David, congratulatins on a good call.

My question would be, with the returns you could anticipate given your target for the S&P 500, why you were not more aggressive in putting your cash to work.

Sep 16 12:27 PM

[David Van K...:]

Thanks for the comments.

Thiazole, thanks for the congrats. Good point about going against the tide. Although, to be honest, I didn't feel like I was going against the tide, I felt like I was riding the wave. The market, after all, was going up. So although the criticism was loud, and the majority view on this site, it was clearly not in the majority in the market itself. I read this somewhere: "Don't take investment advice from someone who is screaming." So I don't watch Cramer, I've stopped watching Bulls & Bears (which used to be a pretty good show), and I look only for logic from those who scream their comments here (and don't find much).

Tom, Good question: Why didn't I go all in? My original article was simply "making a case" that something could happen. (There were many other cases--negative ones--being made that were as logical as mine, or seemed so at the time.) I had begun investing into the rally about three weeks after it started, and I wrote the article about three weeks after that. Risk management is very important to me, maybe Job 1. So my initial investing was cautious and protected by sell-stops. That combination comprised my risk management technique. I actually gained confidence as the rally continued, which encouraged me to keep investing into it. My confidence grew as the "net news flow" remained positive and as the market continued to react to it in the same way. I guess my approach reflects my risk tolerance profile. Anyway, I'm all-in now.

Sep 16 02:14 PM

[Referee:]

and the river card is ........


a joker


On Sep 16 02:14 PM David Van Knapp wrote:
> Anyway, I'm all-in now.

Sep 16 03:31 PM

[Ricard:]

Congrats on the brave calls. Well done on calling the level of the index up to this point.

Well, since we're all patting each other on the backs, I'll add in my own call in May:

seekingalpha.com/artic...

Strangely enough, the only negative comments I got were from our favorite shill Cetin - he thought that small caps were not the place to be. It has been one great ride, and I have cashed out many of my chips.

Sep 19 12:19 AM

[cayman:]

Just found your article from May and then these two follows up. interesting that you did not go all in or significantly in back in March based on your assumptions.

I slept on your assumptions, and came to the conclusion that this is not your normal recession and probably wont end in the normal way and the return to growth trajectory might be different from previous.

Even with hindsight, I can understand why u went in with a small position. But as to why you are all in now, when the risk profile of the market is different beats me....unless u think we are just going to tread slowly higher from here. ????

Nov 12 01:03 PM