Sunday Musings: A Sucker’s Rally?

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The past week’s rally has been one of the strongest on record in some 30 years. As I said before, these kinds of rebounds don’t happen in bull markets but only in bearish environments when markets have been pushed down to extreme levels.

While those who have held on to their losing positions throughout year are cheering loudly, it’s questionable whether this current up move will be anything other than a sucker’s rally. For some thoughts on that, let’s listen in to Dr. Housing Bubble, who had these comments a couple of days ago:

We’ve just witnessed one of the most potent and unrelenting bear market rallies in history. And all it took was 4-days. Over this 4-day rally, the Dow Jones Industrial Average is up 15.5% which is the biggest run-up since August of 1932 during the Great Depression. The S & P 500 has even done better shooting up 18% and the NASDAQ is up 16.4%. Taken alone, these would be excellent returns for one year. With such a strong rally, you would think that the markets would be back at par but nothing can be further from the truth.

So how are the markets performing for the year after this stunning rally?

Even after this historic rally, for the year the Dow is down 34%, S & P 500 is down 39%, and the NASDAQ is down 42%. It would be one thing if this rally was fueled by excellent earnings, strong employment numbers, or superb retail numbers but none of this has occurred over this time. Let us recap the excellent news over the 4-day rally:

Friday November 21: Big 3 automakers continue to beg with tin cup in hand for more money from an already broke government. Citigroup on the verge of going off a cliff.

Monday November 24: Existing home sales come in at a weak 4.98 million while the market expected 5.05 million. Citigroup received a bailout over the weekend injecting more capital into the ailing bank while backstopping $306 billion in toxic mortgages, which comes out to be half of the already committed TARP plan. Consider this a mini TARP for Citi.

Tuesday November 25: GDP showing even more contraction coming in at -0.5 when the market expected -0.3. Consumer confidence is still at record lows. Absurd bailout of consumer and mortgage back security debt which is already committed from the Fannie Mae and Freddie Mac bailouts.

Wednesday November 26: Durable orders fell a stunning 6.2% when the market only expected a drop of 2.5%. Unemployment claims are still running high at 529,000. Over 500,000 easily puts us into recession territory. Personal spending fell a strong -1% when the market was looking at -0.7%. The Chicago PMI got hammered into the ground while new home sales are at half century lows.

This was the fantastic news that made our markets rally. Make no mistake. This was a suckers rally.

This is the first time since the 1950s that the S & P 500 dividend yield is higher than the 10-year Treasury yield. I’m certain many fund managers started dumping money into the market because of the following reasons:

(a) The above notion of value investing and trying to lock in short-term gains before the year is over.

(b) Big fund investors trying to play “guess the next bailout” and dumping money into certain battered down financials.

(c) Assuming many of the S & P 500 firms will have earnings in 2009.

I think the final point above is the biggest problem. This current notion that the yield is signifying a bottom simply assumes that many of these companies will remain at their same earnings levels next year. This is not going to happen. As I wrote in a previous article highlighting 10 reasons why this will be the worst recession since World War II, next year will be even worse than 2008. So the delusional idea that many of the companies will continue to pump out dividends is insane when unemployment will be rising and our crushing debt will force us into austerity.

The recent rally happened for 2 main reasons in my humble opinion:

(1) A leadership vacuum was filled. This doesn’t mean anything has materially or fundamentally changed. But the mere sense something new is coming along gave the market new feet.

(2) We hit technical lows. The market fell so quickly and breached so many technical support levels that we were bound to hit a retrenchment point. We did. The question that remains is whether this sucker rally has any legs. The news will continue to be bad so if it does rally, it will be based on purely speculative reasons and we know where that will lead us.

I’m in total agreement with this analysis; however, I would not be surprised if this current rally continues for a little while longer before the next reality check pulls the major indexes back down.

Whether this happens or not makes really no difference to those of us following long-term trends, since we have a clearly defined plan to re-enter the markets; whenever this point in time occurs.

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