Stocks have posted a very impressive rally over the past year. In fact, the S&P 500 has gained 73% from the March 2009 low of 666. But this devilish support level will likely be tested again before the year is through.
I view the 2009 rally as nothing more than a dead cat bounce that has been fueled by government stimulus, quantitative easing, accounting trickery and unprecedented investor optimism. But faith in the markets seems to be running a little thin lately, as the rally begins to lose steam and reality begins to set in.
Not even news of 5.9% GDP growth in the fourth quarter of 2009 was enough to buoy the markets, as the S&P 500 ran into stiff resistance around the 61.8% Fibonacci retracement level and has dropped nearly 8% in the two weeks since. This decline is the most severe in the shortest time period since the “recovery” began.
So while the 9-month dead cat bounce has been quite remarkable, it is a dead cat bounce nonetheless. At some point in the coming months, I fully expect the stock market to be entering the second phase of the double dip recession.
Some are expecting the plunge protection team (PPT) to intervene and work its magic in the coming days, but all eyes are on the January employment report due out later today. I have a feeling that even if the report comes in better than expected, the optimism will be short lived. There is an overwhelmingly bearish sentiment in the investment community at the present time and with good reason. The threat of deflation looms large as banks are not lending, credit is contracting, businesses are not borrowing and unemployment remains at lofty levels.
While the official statistics can be massaged by government agencies that clearly have a directive to paint as pretty a picture as possible, there are some non-biased indicators that we can use to get an idea of how strong the “recovery” actually is. One of those measures is the Baltic Dry Index or BDI. The BDI measures the worldwide demand for shipping capacity versus the supply of dry bulk carriers. Because dry bulk primarily consists of materials that function as raw material inputs to the production of intermediate or finished goods, such as concrete, electricity, steel, and food, the index is also seen as an efficient economic indicator of future economic growth and production. It also provides an accurate barometer of the volume of global trade — devoid of political and other agenda concerns.”
The BDI tends to forecast economic activity a few months in advance and the prediction will often manifest in the movements of the S&P 500. For instance, when the market declined sharply in September/October of 2008, the BDI had already began to decline in July/August. Likewise, the BDI shot up sharply in January of 2009 – two months prior to the March start of the rally. And so it goes with the current decline which began on January 20th, but was predicted by the BDI index starting in late November/early December. If this trend continues, the recent drop to 2,600 suggests continued weakness in stocks during 2010.
Magic crystal balls aside, there are some very concerning fundamental reasons to believe that the market is getting ready to double dip. Consider the following chart on mortgage rate resets put out by Credit Suisse.
As this chart illustrates, 2009 was a relative lull in terms of rate resets and has helped the real estate market to stabilize. But 2010 and 2011 will see a spike in rate resets on higher quality adjustable-rate mortgages, which I believe will send housing prices lower and foreclosure rates much higher. 2009 was the calm before the storm and helped to provide an atmosphere in which the S&P could rally as it did. But the storm clouds are once again gathering in the residential real estate market, which will only be compounded by the rising vacancy rates in the commercial real estate market. If the Fed raises interest rates this year as many expect, the situation will get exponentially worse. This is particularly true of commercial real estate, where tax rules have encouraged owners to pay as little in principal as possible so as to write off the interest expense.
It would be foolish to underestimate just how important the housing boom has been to the economic progress and good times that we’ve experienced during the past decade. The rally of 2009 may not have occurred if it weren’t for the stabilization of the real estate market and that brief reprieve is now vanishing fast in the rear view mirror.
I have been short the stock market over the past week and plan to continue doing so throughout much of 2010, barring any major shift in sentiment. I believe precious metals are likely to get dragged down with the initial market decline and dollar rally. However, as occurred in the past, gold and silver will soon break free from these binds and move higher on their own merit as a safe haven investment and means for not only maintaining, but increasing purchasing power.