Tsachy Mishal's  Instablog

That the market would eventually pull back after rallying 40% off the lows was the easy trade. However, in the coming weeks investors will need to decide if this is indeed the start of a new bull market or a bear market rally.

I am in no rush to make a decision as I believe that even if this is a new bull market that this correction has further to go. After a two month 40% run, I would expect a correction that lasts at least a few weeks.

In the past two weeks we have seen companies issuing shares at a record pace. The flood of equity issuance is set to continue in the coming weeks, albeit at a slower pace. This supply should keep a lid on the market. Given that I believe that the upside is limited in the short term, there is little harm in waiting a few weeks to see where this correction will take us.

While a bull market from these levels would not likely go very far, I don't want to rule it out. The Obama stimulus should start hitting the economy this Summer, while the Federal Reserve is printing money. There is no precedent for such action. At the same time I don't want to rule out revisiting the lows. For now, I am biding my time and keeping an open mind.

When the initial burst off the bottom in 2003 occurred there was a large sentiment shift, similar to what we are seeing today. At the time, the US invaded Iraq and with each military victory the market shot higher. This time around we have the stress tests, which are proving to be an even easier challenge than Saddam Hussein was. It seems that everyone remembers 2003 and believe they know what happens next.

While the current period bears some similarities to 2003, the differences are far more prominent. In 2003 companies were announcing large buybacks and we were at the nascent stages of an LBO boom. Currently, companies and insiders are selling stock into the market at a pace never seen before. Back then we were at the early stages of a real estate and credit bubble. Every day new methods were being invented on how to turn one's house into an ATM. Today we have massive over capacity in real estate and consumers are delevaraging. Back then corporate taxes were being lowered, while Barack Obama is planning on closing tax loopholes that will likely result in a 4% reduction in corporate earnings.

The rate of decline has slowed, but there is little evidence of an expansion. What sectors are expanding and will lead us? The truth is that the market's rise is convincing investors of a recovery. It is not considered intellectual to say that one is bullish because the market is going up. As a result, intellectual sounding stories are concocted to make joining the herd seem like a logical decision.

Bearishness reached an extreme that I have never seen two months ago. The recent rally was an unwinding of that extreme sentiment and in my opinion has run its course. The easy money trade has gone from shorting anything with leverage to buying anything with leverage. My experience with easy money trades, is that one should run in the opposite direction.

Tops are harder to call than bottoms as extreme positive sentiment can last for a while. In contrast, extreme negative sentiment typically reverses pretty quickly. However, I believe that the high level of secondary offerings that is expected to persist will make staying at these lofty levels harder than usual. Additionally, gains are much harder to come by once sentiment has reached an extreme. Even people who believe that this is a bear market rally, believe it is too dangerous to fight it. I am very encouraged by that, as it is the type of sentiment seen at market tops. The time to buy was two months ago, the time to sell is now.

Regardless if one believes that this is a bear market rally or a new bull market, a correction seems forthcoming. For the past six weeks the market has only had brief pullbacks that lasted one to two days. The S&P 500 now sits approximately 30% off its lows and has not taken a breather. There is long list of evidence pointing to a correction beginning this week.