This is a Stocks Bear Market Rally

By: Paul_J_Nolte

It seems as all investors are from Missouri, the show-me state, inasmuch as they would like to embrace the latest run in stocks, they are leery that another break is just around the corner. Spurring stocks higher were commends from a variety of banks that they were profitable in the early months of the year (this does not include any nasty write-downs of toxic debt!). With a yield curve as steep as it is, it really should be of little surprise that “regular” banking is profitable – pay little for CDs and make loans at four percentage points more.

But behind the euphoria lurked still bad news on employment (new claims continue to rise) and imports down (confirming a cautious consumer). Coming up this week will be housing related data (will it ever get better?) as well as industrial production and capacity (little production, lots of capacity – not good for growth). What keeps us from getting too giddy about a “new bull” market is that many are calling Monday’s swoon the bottom – too much like a watched pot, it will never boil if all eyes are glued to it!

Last week we set up the possibility for further losses in stock prices before we finally get to a bottom that might be meaningful for investors, we just don’t believe that “the” bottom arrived last Monday. Certainly ripe for a strong rally, the folks from Missouri would like to see more evidence that a real bottom has arrived. We are looking for many of our indicators to actually surpass prior peaks before we are willing to declare a bottom. The last four trading days saw advancing volume in excess of three times declining for the first time since the November bottom.

However, once past the initial pop, stocks managed to rise only 10% more over the following four weeks before rolling back over – and before they surpassed any prior peaks. With all the excitement around the rally, Friday’s close is just a hair above the lows (on the Dow) put in November and have yet to erase half of the losses generated since early February. While we are encouraged (and relieved!) by the rally, we would like to see those other signposts passed before we get excited about putting money to work over the short-term. Long-term investors that can stomach the still volatile short-term movements can and should slowly add to current holdings, as whatever downside is left should be much less than we have already experienced.

The bond market is beginning to respond to the increasing size of issuance to support the ballooning deficit brought on by the Fed’s activities with the banks. So far, the bond model is positive, but barely so as any modest increase in commodity prices or rise in short-term rates would push the model into negative territory. As mentioned above, the current spread between short and long-term rates is above three percentage points. This relationship as existed for much of the past year, however if we go back to the “recession” during the ’01-’03 market decline, the spreads remained over 300 basis points for three years. This was also true during the economic slowdown from ’91-’94. So, we can expect another two or more years of a very steep yield curve to assist in getting the banks back to profitability.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

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