Investors have been hoping against hope that the big rebound in the stock market on July 16th and 17th signaled the end to the 2008 bear market.
Bulls trotted out a lot of reasons for their belief based on their subjective interpretation of the past, but primarily suggested that the government would not allow the sharp declines of early July to get out of hand; banks’ earnings were not as bad as expected; raw energy prices would crack; and a lot of money is ready to flood in from the sidelines.
The problem is that the reality is a lot more messy than such a neat list.
The truth is:
1. Financial companies have reported earnings that were a touch better than the most pessimistic estimates, but now estimates for next quarter and next year are still too high.
2. Although everyone likes to think of the government as omnipotent in times of crisis, it’s the plain fact that it has endured many heartbreaking failures in the past that is conveniently forgotten.
Government regulators have blown their opportunity to prevent or curb the credit crisis at every turn and have repeatedly caved in to the industry they are supposed to watchdog. For instance, whatever happened to Treasury Secretary Hank Paulson’s plan last fall to create a SIV "superfund" to clean up banks’ trillion-dollar off-balance sheet entities? (Answer: Industry lobbyists killed it.)
3. Crude oil prices fell for a grand total of three days in mid-July.
Big whoop. I know that "demand destruction" from a global recession and new pressure on speculators are supposed to kill off energy demand. But so far it has remained resilient as emerging-markets’ needs persisted. Now just wait for a big hurricane to roar along the Gulf of Mexico and see how long gas prices stay down.
4. Money that is sitting on the sidelines is there for a good reason. It’s not going to come storming back into American stocks if the world believes that the United States is near the beginning of a recession. It will come in toward the middle or end of a recession, and that may not come until the end of the year.
Add all this up, and you can still have a rally if value-oriented buyers begin to swamp sellers.
But as I told readers of my newsletters, beneath the surface of the seemingly strong market last week sellers were strangely persistent—and buyers were not particularly aggressive.
That trend followed through this week. The percent of total trading volume that went into advancing stocks in each of the first four days of the rally, starting July 16th, were 80%, 72%, 61% and 52% according to Lowrys Reports research. You don’t have to be much of an expert to realize that trend is going the wrong direction.
Moreover, most of the rebound on Wednesday and Thursday last week occurred in companies with the worst current and projected earnings fundamentals: banks and brokers.
And it was curious, to say the least, that the rally coincided with the Securities and Exchange Commission’s announcement of new rules to curb naked short-selling in those companies.
This little fact makes it more clear than ever that the rally was more about short-covering than value buying. Most high-quality technology, drug and transportation stocks barely budged in the past week while glamour companies Apple (AAPL) and Google (GOOG) have actually fallen hard.
In short, this is not the sort of free-wheeling, zoomy action that you typically see at the start of major new bull markets.
You do often see a slight retracement of the initial upward impulse in the second week of a new bull phase—something akin to a school bus turning back to pick up some straggling kids before heading toward its destination.
But the negative action on Monday and Tuesday in the large-cap indexes has come too early to be that kind of activity.
Now don’t think I’m nothing but bearish. Far from it, as subscribers of my Traders Advantage newsletter made up to 27% from buying the common stock of Bank of America (BAC) from Wednesday through Monday and up to 250% in recommended call options.
That’s not too bad for a three or four day hold.
Yet now the strong up move appears to be over, and I’m urging caution. In the best-case scenario, the S&P 500 has a shot at rising toward 1,325 before being seriously whacked again, but the evidence suggests that sellers may still be too anxious to dump stocks to permit that much of a rebound.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.
