Thursday's Market 'Melt-Up'

There was a whiff of panic buying on Thursday as the market careened higher. The dip at the open was the signal for shorts to cover and traders to buy as the disappointment from the Fed yesterday was quickly forgotten.

The catalyst appeared to be Treasury Secretary Hank Paulson’s musing that the end of the credit crisis was near. However, even if Paulson said nothing, I’m pretty sure the market would have found an excuse to go up anyways. The market wants to go higher - it's as simple as that.

How much higher is yet to be seen. The most recent AAII poll showed the highest percentage of bulls and lowest percentage of bears since the peak of the market in October.

My base case is that we will be in a trading range for some time, perhaps a couple of years, with the top of the range somewhere near the October highs and the bottom near the Bear Stearns (BSC) low. The market is a discounting mechanism. In order to think that this move presages a break out to the upside, one must believe that the economic slowdown is nearly over.

I am highly doubtful it is. Instead, I think we are in for a period of slow growth, dipping in and out of recession for some time as we work off the excesses in the economy and the consumer repairs his/her balance sheet. When it appears that the economy is going to get worse, then the market will get hammered. When it appears that the economy is not going to collapse, you will get violent relief rallies, like we are seeing now.

The wildcard is home prices. If home prices continue falling, we may break through our lows. On the other hand, if there is any evidence of a bottom, stocks could challenge the highs.

When the idiocy in the housing market was bubbling, I figured we would eventually get a 20% drop in home prices. According to the most recent Case-Shiller index, prices have dropped 15%. Given the fragility of the banks, and the accelerating write-offs coming in the regional banks, I am unsure if another 5% is being discounted by stocks.

Also weighing on the consumer is employment. New jobless claims for last week were 380,000. Excluding the week of Good Friday, which economists have said distorted the data, this is the highest level of new claims since Hurricane Katrina, and the highest since early 2004 excluding natural disasters. Continuing claims broke the 3 million mark for the first time since 2004 when the economy was accelerating out of a recession.

To think that this rally is based on sound fundamental foundations, one must believe that the claims numbers will peak over the next several months. Perhaps, but I think this rally is a continuation of the unwinding of The End of the World Trade, which is heading into euphoric stage. I do not believe the market is discounting The Economy is Stagnant for Longer than You Think Trade.

Anyways, we have to respect the tape. As I said yesterday, I think there is more to come on the upside. I still believe this, though a pullback over the next few days is likely. Nor do I think the commodities sell-off is finished. However, given the dovish statement of the FOMC on Wednesday, as well as its outlook and continued concerns about the credit markets, the stage is set for a reversal of the long risky assets/short commodities in the not too distant future.

Comments

[RichardMendales]

We have not yet seen a genuine bear market, but if recent moves by regulators do create an unwarranted euphoria in the markets, the next serious problem to emerge could create just that.

[drmalaka]

I agree that for now the market wants to go higher but wanting something will not make it right in the long run. For those who say that the market is a discounting mechanism, that is correct many times, but I ask you how correct was it in 2000 when the NASDAQ was at 5000? How correct was it in Sep/Oct last year when we rallied 10% to new highs?

The forward looking idea of the market is forward looking when the market is correct. We must ask if we are correct here? Is housing near a bottom? Will banks lend the homebuilders money in the comming months to help their balance sheets or will credit stay tight forcing several homebuilders into bankruptcy?

As for inflation, what we are seeing is not inflation, it is rising commodity prices. They are not one in the same. If money remains constant and gas and food prices go up then that means prices of other goods MUST decrease, as there is less money left over to spend on these items after food and gas. Inflation would dictate that all prices rise.

With that thought in mind, if those other prices go down what happens to the economy? Prices will have to go down in service industries (go to the hairdresser once ever three weeks instead of two), housing prices drop....this will hurt our economy which would make sense with the article premis that we will have a boring economy for a while.

[oilsands]

Good article, but I have to agree with the two cautionary dcomments above. I fear another, more severe, bear before we are finally in balance. New jobs, working toward energy independence and rebuilding the infrastructure will blossom when Bush is gone, so there is hope in the future.