…since the October 11 highs on the Dow this is the fourth major attempt to rally and each has produced a lower high, and only the last subsequent selloff failed to produce a lower low…on the Dow. The fourth attempt made two thrust the second high inches below the prior one and so that level, which we are rapidly approaching with no visible resistance (12756 on 2/27 and 12767 on 2/1), should be easily attained as there is no other resistance until then…and since those targets are just 200 points higher TB is content to wait before plunging in. Even then this could still be just a bear market rally, which TB fully believes it is but based on the irrational (to TB’s way of thinking) comments on how a bailout can solve the massive global financial crisis we face, TB will wade in slowly…once those targets are reached. So today let’s examine some of the reasons for doubt:
1. the continued weakness in the economy with an employment situation that is much worse than it appears, especially in financial services and construction (manufacturing however may get a boost as foreign companies are now finding it cheaper to produce here than in Europe…aside from states like Michigan, California, New York etc that are unfavorable to business). The housing market which had a boost in existing home sales, this will be a tough year for seasonals however since we had a mild winter in most places and an early Easter.
2. The steepness of the yield curve which has been exacerbated by the flight to quality and problems with monoline insurers thus destroying the auction rate securities market and driving short term rates well below the Fed Funds rate…the 5 yr note yields just 37 basis points over Fed Funds! This should attract money to the longer maturities pulling those rates down and perhaps leading to lower mortgage rates.
3. The financial crisis, as discussed yesterday is not by any means over…some say that the collapse of the Bear was the low point…and it might well be for brokers, but if so, why did Goldie rally yesterday only to end the day to the downside, while troubled Lehman plunged further…the sole benefactor was Merrill…and that will be short-lived as JPM just lowered their earnings forecast (-1-2% overnight)! TB cannot say too often: where will the replacement revenues come from? The situation is worse on the banking side as delinquencies and foreclosures continue to rise and due to bank accounting rules they cannot write down in anticipation as the brokers do, until the event occurs, which also triggers increases in loan loss reserves. With the peak in subprime resets not until early in the 3rd quarter, it will be a tough year for the banks. Worse yet are the non-bank financials, witness CIT which, as the banking problems continue will find it harder to fund loans…witness CIT, and the smaller, not necessarily weaker, lenders. Bush has repeatedly said small business is the backbone of the economy, and that is correct, but with their credit lines being reduced and any number of other problems they cannot be expected to carry the burden. Now perhaps the GOP can see how they have suffered at the expense of big business and tax cuts for the wealthiest Americans. This will be a huge drag on growth.
4. The twin deficits which are finding it hard to improve while funding a war in Iraq and Afghanistan, and fiscal stimulus that is assured to fail as it will be used for the most part for living expenses or to pay down debt…yet it is a necessity…something has to be done. The weak dollar is also hurting the trade balance.
5. Election year. If the best combination historically for the stock market has been a Democratic President and a GOP Congress, the worst is that both be Democrat. This is based on history not ideology, but look what happened under a GOP President with a GOP President…and how little better has happened with the shift of power in Congress to the Dems? With lobbyists in control it will be difficult to change much of anything…a sad story. Also, the first year of a new President is not the best for the stock market or economy.
TB is sure he has left out many other factors but let’s return to the stock market for technical clues.
1. S&P 500: This index did put in a new low but there was no capitulation trade like we had in January. There was a delayed reaction of a day but this may have been due to the Bear Stearns solution not being clear at the time. This is the key to TB has it has had a much more even pattern of lower highs and lower lows than the Dow. The S&P 500 closed at 1350 yesterday with a 20 point gain…so TB has the patience to wait a pit longer for two key double tops above: the first, 1388 was created on 2/26-27 and taking it out would break the series of lower highs but why not wait for just 8 more points to the 2/1-2/4 396 tops? IF that is taken out the rally has legs, and TB doesn’t believe it does. There are two many things that could kill it in the interim.
2. Dow Transports: Yesterday on a massive spike, the index took out a series of tops at 4826-28 and closed at 4861. Given the high energy costs this is impressive. Also only one index member LUV which has had big fines due to faulty aircraft, was down and that only slightly…the rest were up big! Watch it!
3. Nasdaq and Russell 2000. These were among the best gainers yesterday and have also been beaten up the most. Yet they have to go significantly higher just to get to any meaningful resistance, so they could be the canary in the coal mine.
4. Bonds. We need to see further weakness in the front end of the curve and continued strength in the long end after yesterday’s big selloff to help the financial problems we face. Of course, if the dollar continues to decline it will make it that much more difficult to attract foreign investors.
These are just a few things that could make or break this ‘rally’ and determine whether it is real or Memorex. Had we taken that one last big hit and then had a capitulation trade TB would be on board, but as things stand he is content to stay sidelined. There is one exception: as TB has reported lately, it is the same stocks that are the big movers every day (XOM, AAPL, RIMM, GOOG, and BTI and IMO on the AMEX). But yesterday it was broader with some of the strugglers doing better like CAT, AXP, BA and other defense stocks. Meanwhile some of the stocks he has been following that have not gone down too badly but boast nice dividends with double digit growth rates, reasonable p/e’s and solid earnings growth have not yet participated in the rally…some of those could be bought here. TB leaves it to you to decide which ones they are. Remember TB knows no more than anyone else, he just offers these thoughts to aid your decision making. That, to TB is more valuable than any guru. Good luck!
We live in trying times…invest accordingly.
All the best,TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC March 25, 2008
