Bruce Pile

Why This Rally Is Unsustainable

Doug Kass is building some short positions in anticipation of what he sees as a 5-6% correction per the comment Jim Cramer made on his friday show. But this rally has already had a 5% selloff, at least in the Russell 2000 (April 20) and, like a train running over a possum, you didn't even notice. Why try to trade around it?

Earnings Season: U.S. Banks Will Make or Break the Rally

The rally is at an interesting historical juncture with the banks. A lot of purely price chart technicals seem to show a significant turn point to the upside. For example, look at the article here at SA on April 10 by Dr. Duru "Rare Market Indicator Sighting: T2108 Over 90%". The T2108 (it's name in Telechart) is the percentage of stocks trading above their 40 dma. This is indeed very rare. As Dr. Duru points out, since the 80s, the only 7 times it goes to 90% or higher ('91 and '03) it was at turn points into big climbs. Over at safehaven.com/article-..., there is an article with a charting of the T2108 under an S&P 500 chart going back to '97. The author uses it to point out that the elevated reading means an overbought market top. But that's the short term read as the T2108 typically goes to around 80 at most tops in either decline or climb mode. But at those rare junctures where a transition takes place from decline to climb, the T2108 goes a little above that level to the rare 90 level. It did just before the big climb in '97 and again in early '03 switching from the last bear market. The only other time on this weekly T2108 chart is now!

Whether you believe an improvement in fundamentals is causing it or you think, as I do, that a rally is being "forced' by the government and its unprecedented intervention into the banks and may not at all be the end of the bear market resulting in a premature move to 90 by the T2108, you have to consider the mounting evidence for at least a short-term move up. What the banks' reports say now will probably provide some weight to pull the market higher.

Making Sense of New Market Lows

The market has announced it's major direction from the limbo it's been in by breaking the broad index Russell and S&P support levels and moving the VIX out of its quiet consolidation to the upside. Knowing this market, however, this is probably some carefully crafted disinformation.

If you look at the VIX over the '00-'03 period, you see that a low was not put in until the VIX made a new high. This would suggest that we have to see our VIX travel all the way back up to about 80 from our present 50 while a large move down proceeds.

The quieting VIX and other indicators was presenting a viable threat of a sharp bear rally, but that looks less likely now.

You could be 30% in cash, 25% or more in short or double short positions, only around 10% or less in long positions, and have the rest in gold positions, and still not be bearish enough. This market seems bent on punishing prudence. That saying "Bulls make money, bears make money, pigs get slaughtered" is foreign to this market. The new rule is to be 100% double short, set it and forget it, and go fishin'.

The Economy, And Why It's Taking So Long to Fix It

If you accept the premise that the stock market knows all and will turn at least 6 months ahead of the economy, you should be discouraged by this week's action. There were some signs that the S&P broad market would hold the 750 support and head into a bear market rally. But such rallies almost always have a vigorous start up from a support level (see the triple bottom at the 800 level during the '02-'03 series of rallies). This week saw one big up day with no follow through whatsoever, but instead a wilt back down through the support level on very high volume - more volume than the bounce day. Not good. The other major indexes have already breached this support including the transports.

So it looks more likely the market will continue to drift lower. Let's hope it's a drift as opposed to a crash. Inverse investments will probably continue to be the only good area - short ETFs, gold, and now maybe even oil stocks. Both gold and oil typically move inversely to the broad stock market during bear markets. Gold was moving in synch with stocks last year but has since clearly broken free to go up as the market goes down. Oil stocks are still moving closely in synch with stocks, but oil itself may be breaking back into a climb having actually just now broken back above its 50 dma at least briefly. Oil stocks may now be where the gold stocks were back in early December, when you should have been loading the boat with them. But it's too early to make any heavy bets on the oil stocks unless you are bravely trying to nab some very near their absolute bottom.

Fundamentals, Valuations and Technicals Stress Need for Patience

Buy the massacres, sell the recoveries seems to be the only "investment" strategy that is working now. The market doesn't care much about valuation except to add strength to the bounce backs. So the market isn't rewarding very many stocks with persistent climbs. That's probably the way it will be until the market gets some clearer vision on future valuations.

The gold stocks may be the exception to this, but they are due for a massacre themselves.

Financials Bring Down the Market, Again; Hoping for an Obama Bounce

The financials ($SPF) provide an important clue as to whether the broad market is tanking to test the November low. They have been leading the market and they are already at their November low!

Short Covering Helps Boost Stocks

Eventually, the debt problems will get fixed. But as Satyajit Das highlights in Traders, Guns, & Money, this credit crisis is all about the unknown. And what is it that the stock market abhors more than anything? Uncertainty, of course. That is the very defining feature of the current market problems. Das even subtitled his book Knowns and UNKNOWNS in the Dazzling World of Derivatives (emphasis added). The market's habit of shooting first and sorting it out later is making this a most dangerous stock market. That's one nice thing about the commodities market as opposed to the stock market - whatever the fix winds up being for the credit mess, it's a pretty safe bet it will mean big increases in money supply and inflation and investing money rotating into hard assets as shown in the chart I mentioned in my post above (I gave the incorrect Drumbeat date, by the way; it's March 8). At some point, the stock market will see enough resolution to turn back to a bull market. But the waters may be pretty murky for awhile. Not so with the bull market in commodities.

Short Covering Helps Boost Stocks

Whether the latest move by the Fed is inflationary or not (sounds a little fishy to me, but I'm not a banker) is perhaps not the critical question. We have plenty of inflation already with more on the way.

Technically (which efficient market theory says is "all things considered") we have the leadership areas that have lead the start of the bull and the roll over process into the bear being the small cap and value end of the spectrums, and they have already thoroughly broken lower than their January lows (look at $RUT, $RUV, $IJE, etc.). The broader market has been very faithfully following the lead of these groups, which strongly suggests that, after some bouncing, the S&P 500 will take up residence below its January low.

This whole market condition in '08 is remarkably similar to the 70s. After the 70s, every economic downturn has been countered with a Fed loosening. This brought the investment money on the sidelines back into the stock market because there was no problem inflation. But now we have a downturn CAUSED by loose money and the Fed must fight loose money with still more loose money. The mounting inflation caused by this is causing the money on the sidelines, which stands at high levels seen at stock market bottoms, to choose commodities over stocks, which causes still more inflation! It's a cycle that feeds on itself somewhat.

We had this in the 70s where the stock market made no progress for the 15 years from '66 to '82, but a 15 year commodities bull raged. The 70s version was defused by, among other things, a quick return to very cheap oil in the mid '80s. But in our current version, we are going to have very much more expensive oil. The defusing of this investment money inflationary spiral effect may be tough this time. If you look at a chart of paper vs hard asset investing over the decades, you see a clear and powerful cycle at work and where we are now in that cycle. I posted this chart at www.theoildrum.com/nod...
If this doesn't link directly, go to "Drumbeat" for March 9 and scroll down to near the bottom of comments for the chart - posted by "netfind". It clearly shows where we are on the issue of over/under valuation of commodities.