Get Ready for the Last Rally

It’s hard to believe that it has been a month since I contributed the article “No Time for Complacency: This is a Bear Market”. The article, in which I suggested that we would see a 1310-1390 range (S&P 500 had closed at 1392) over the “next few months”, has proved to be right on target thus far. I had written it to close out a temporary respite I had taken from being a bear. On January 20^th, I had contributed “The Bear Turns Mildly Bullish”. Imagine how foolish I felt on the 21^st, when Europe plunged (inexplicably at the time). Not only had I seemingly ruined what has been a pretty decent public record of market-timing over the past year, but it sure looked like I was going to lose a ton of dough as well! Fortunately, it all worked out well, and we recovered from very oversold conditions. Well, this article finds me feeling very similarly to how I was looking at the market back then: We are due for a rally.

A rally? Am I insane? Don’t get me wrong, I still expect another large decline later this year. The source, though, most likely won’t be the area upon which EVERYONE is focused: Financials. No, the 2^nd half of the bear market will come from the profit margin erosion in other sectors. Slowing of non-U.S. economies won’t help matters either. Add in some concerns about the elections (taxes, capital gains taxes, etc.), and it could be a long, nasty summer. I digress, though. Why do I think that the range, which was tested successfully on March 4^th, remains intact? As I mentioned, there is way too much focus on financials for any real surprises to come from there. It’s bad, getting worse, horrible yada yada yada. Not to minimize how significant the problems are, it’s just that we all know it now (finally). I can read all about it, but, even better, the following chart of the Financial Select Sector (XLF) tells me even more clearly – check out the volume:

Notice how much the volume has escalated? Everyone and his brother is hedging or shorting. It shows up in the leveraged ETFs out of Ultra Financials ProShares (UYG) and UltraShort Financials ProShares (SKF). As I write this, I know that in the morning we will all be hearing about Thornburg’s (TMA) demise – what a shock. They had $2 billion of equity and $32 billion of debt – talk about leverage! I thought we learned that lesson back in 1998 with LTCM.

So, here is what I expect over this month – that which will hurt the most market participants. That’s what the market likes to do! I think that not only will we revisit the levels we saw last week (1390 on the S&P 500 (SPY)), but then some. I expect a head-fake rally that will make the shorts cringe, the cash-heavy long-only guys panic and the fully invested gloat. I am talking about a print of 1415 or so. For you PowerShares QQQ (QQQQ) fans, expect 45.5 to 46 (a lower percentage than the broad market). Expect the Financials to lead and Consumer Discretionary to do very well. Maybe we get lucky and Energy doesn’t. The market is still extremely oversold despite the consolidation over the past six weeks:

Despite being pretty bearish longer-term, I remain optimistic regarding unemployment statistics. We didn’t add a lot of jobs in the expansion, and I don’t expect that the job losses will be that great during the contraction. This Friday, we get a chance to test my thesis. So, bears, be patient and bulls, be careful!

Disclosure: Long UYG

Comments

[bhakta]

I can't say whether you are right or wrong for the next thirty days, but I am quite sure we are going to go down a lot further this year before we see any permanent base formed.

[RW]

Alan, what sector do you think will be hardest hit in the long term(after the short rally and the end of the summer) and why?

[Malkiel]

I would imagine election issues might bring on bad or good days, but the only clear narrative element we can foresee to affect the market in a big way this calendar year is the election itself. Regardless of who wins the nominations and election, the symbolic end of the Bush era on election day should generate a big November rally. If that rally fails to break the misery then we'll truly be forced to wait for good economic news, which might take a couple of years to show up...

[AlanBrochstein]

The sectors that I expect to perform most poorly over the balance of the year are Industrials and Technology. It is there that the profit margins are most exaggerated and the exposure to weakening foreign economies is the greatest.

[The Level 2Trader]

You got a point here. There seems no clear indication here to point to a recovery. Fed Chairman Mr Ben Bernake himself dare not confirm this in all his speeches.

I feel that being a good and sensitive Trader with the right trading tools will help to profit in this kind of volatile market.

[cheesecake]

i was just thinking about buying some MER calls, at 46 it looked so cheap. we rally next week, i think.

[dmankoff]

with financials so beat up, is there a lot more downside do you guys think? or are we nearing a tradeable bottom? seems to me, that with so many of the big banks trading below or at 1 x book value, some of these, l ike BAC< WFC WB JPM cand USB can be bought here and make good profits later in th eyear....comments?

[cheesecake]

don't go for the banks, they still have large mortgage exposure's which will probably go down in value. i personally highly prefer MER, John Thain is a killer CEO and he is clearing those books at warp speed.

[moose]

Sounds like general, diffuse and overwhelming pessimism. Not a single good word. I'm not knowledgeable enough t o express and defend an opinion but I'm sure a contrarian would come up with something. When do contrarians decide that things are due for a change?

[clear1]

The next 30 days? Do the math on the earnings yield for high quality equity at these prices...could they go lower? (Yes, but can't they always go lower?) I think if you pick up your head, extend your time horizon, "hold your nose" and buy the obvious, globally dominant franchises...you will do just fine. We have been adding to our core holdings in BAC, WFC and LM...and for non-financials, consider HOG, FAST and GGG.

[engineer1]

The trouble right now with the globally dominant franchises is they are mostly owned by mutual funds. Joe mutual fund is selling and getting out of the market depressing many of these stocks. I think that if you wait a while these stocks are going to be an extreme bargain. Right now watch the mutual fund money fleeing the market and correspondingly plenty of selling of these stocks. Good luck out there, do your homework and be carefull.

[deefree]

you're buying HOG? the recession has just started. not much upside in buying into a company that makes expensive motorcycles just as about 20,000 current owners stop making payments on the ones they bought over the last 3 years.

[deefree]

you're buying HOG? the recession has just started. not much upside in buying into a company that makes expensive motorcycles just as about 20,000 current owners stop making payments on the ones they bought over the last 3 years.