Thursday, January 24, 2008

Bear Market Rally?

What was that 600 point swing in the Dow yesterday all about? I suspect a large portion of the rally from the lows was due to short covering, but does that matter? Maybe, maybe not. I have been following markets for a long time (25 years or so) and I don't put much faith in technical indicators - except for one. Yesterday's action produced a Japanese candlestick chart pattern known as a hammer. Simply put, it requires a big selloff and a recovery that sees a market or stock close at its high. It is the most dependable technical indicator I've ever run across and almost always marks a bottom. The question for this market is what kind of bottom? Markets rarely make long term bottoms that look like a V and hammer bottoms are no different. Often, a hammer is followed by a rally and then a selloff that takes the market back near its previous bottom. So, I'm expecting an extension of this rally and then another selloff. That selloff will determine whether this was a real bottom or just a temporary reprieve from the decline.

I suspect that yesterday was a real bottom and not just a bear market rally as some are calling it. I've said previously and I still believe that we will not have a recession this year. As nutty as that sounds with almost everyone else saying recession - or something worse - is inevitable, there are few brave souls out there who agree with me. Brian Wesbury at First Trust is a well respected economist who I've read for many years:

We remain confident that neither a recession, nor any
significant consumer slowdown, is in the cards. The Fed
is not tight, tax rates are still low, productivity is still
strong, wages, incomes, and profit margins are still robust,
and, after revisions, the US economy has proven its
resilience time and time again.

That's from a 1/7 commentary titled "Recession Fears Still Misplaced". His 1/14 commentary is titled "Bad Mood about the Economy Unwarranted". His latest is called "Dow 15000". Which brings me to a point I've been making to clients over the last week or so. What if I'm right? And if I'm wrong, what is the downside? The way I see it, if I'm wrong most of the market decline from a recession is over. If I'm right on the other hand, the upside is huge as the bears cover their shorts and investors lay long term bets. Limited downside and big upside should be a good place for long term investors to commit some funds.

Apparently the participants at the Davos Economic Summit don't agree with me. Everyone there is competing to see who can sound the most pessimistic about the US economy. George Soros was the winner yesterday:

The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.

However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.

I don't disagree with Soros that the US has been on a debt binge for the last 60 years or that the Fed is a huge part of the problem. I just take issue with the idea that the end is nigh. I've been reading about the death of the US consumer my entire lifetime and I suspect the end of the debt supercycle will happen in my lifetime, but this is not it.

I would also point out that last year's Davos produced no insights about the problems that surfaced in the US economy during 2007. They spent most of last year's conference fretting about global warming and the mood was generally upbeat. Soros and the others gathered at Davos are smart people but they can't predict the future any better than anyone else.

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