5 Reasons Why The Rally Won’t Last

Includes: DIA, QQQ, SPY
by: Ryan Edward

1) Credit is still largely frozen, disabling a consumer-led comeback: With the Fed fighting for more credit and liquidity, the government has stepped in the opposite direction recently, with the new credit card laws. These measures were necessary, but not right now. Fact is, it will be harder for students (with little or no credit score) and low credit score consumers to obtain new credit cards. This should work out in both the lenders and consumers favors in the long-run (with the lender receiving better credit, high paying clients), but in today’s market, it’s the one’s with the most credit who are hunkering down. There is credit being lent that isn’t being used and potential creditors not getting their fair chance to help out the economy.

2) Historically, the S&P 500 has bottomed out with EPS around $5 to $9: Although historic metrics are backward thinking, and not always correct, they do give some view on likely potential situations. The earnings on the S&P were attractive before the bad earnings were out, but just a few weeks ago, they traded at a lofty 12x earnings, at least compared to historical comparisons. With the recent run up, it is trading at 15x earnings, even more lofty for this type of recession.

3) Energy prices will hinder the economy yet again: Back when we had peak oil prices, oil and equities traded inversely for large amounts of time. Many companies have had costs slashed enormously due to lower commodity costs. Now that almost every commodity but Natural Gas has been rebounding, it will likely hinder there recovery and growth. Companies that use large amounts of commodities will see relief when the lower prices hit their books, but if commodity prices stay high, they will be hit yet again in the near future.

4) The market rally has been partially fueled by short covering: As a proportion of shares available for trading, or float, short interest for the S&P 500 slumped to 5 percent as of May 15. It’s fallen from 5.6 percent on March 13 and 5.9 percent on July 15. The short covering has been even more dramatic during the month of July, especially on the Nasdaq. This short covering represents no change in fundamentals or economic outlook, and provides money on the sidelines for more short covering once we hit a rally top, accentuating the fall of the rally.

5) Too many ARM’s and ALT-A mortgages have yet to reset: From now until 30 months into the future. Because of the incredibly low rates of the Greenspan era, billions upon billions of dollars worth of adjustable rate mortgages were written, the most in history by a large margin. Although the subprime mortgage dilemma helped us get into this mess, just wait for the next wave of ARM’s to reset. Currently, it appears the value of loans set to adjust is about 25-30% higher than what we saw in the subprime debacle. In the near future, we may see a mortgage problem far worse than the one that catapulted us into this recession.

Feel free to add your own thoughts on whether or not the rally has legs.

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