Relief For Stocks For Awhile?

A couple of weeks ago we wrote that even in Secular Bear Markets, strong rallies can occur. In the Chart Spotlight section we showed a couple of weekly charts that were hinting that a rally may be in the offing. That day the SEC announced naked short selling restrictions on some of the major financial stocks. The financial sector was up over 20% over the next two days, leading the market to a fairly broad rally.

Since that day the tone of the market has firmed and we believe that we could move another 10% or so higher. Don’t get us wrong, we still believe we are in a Secular Bear Market, but counter trend rallies can exceed 50% (see table below). What we would like to do briefly today is describe a few of the dynamics that could be the basis for stocks moving higher over the next several weeks. We believe it is the collective nature of these factors that are important, just one or two of them present would probably not be enough to inspire the market.

Technical Conditions – As we shared last time the weekly charts are showing a positive divergence, which from my experience leads to a multi-week rally. Bonds and oil appear ready to fall which could lead to a rotation of those funds to the equities that have fallen. One very interesting chart that has shown up recently in our work is the possibility of the US Dollar moving higher which could lead to higher interest rates (lower bonds) and higher stock prices.

Sentiment – The Investors Intelligence Bull/Bear Ratio is a poll that is released weekly. It recently depicted some of the most bearish figures in several years. This has been a relatively good contrarian signal as the herd, especially the pessimists at bottoms, tends to be wrong in a relatively reliable way. We guess you can say the herd has been heard?

Short Sellers Targeted - We mentioned that the SEC put restrictions on short selling of several financial stocks recently. Last week they announced they intend to make that a market wide policy. Recently the NYSE released that the outstanding shares short in the market was at all time levels. The only way those trades are closed are by buying those shorted shares. Combine that stat with the new restrictions and that is an impetus for continued buying by these short sellers. One side note; we predict that the SEC will reinstate the uptick rule, another short selling restriction, during the next correction in the market. The policymakers have a few tools they can use to prevent a market meltdown (reply for Plunge Protection Team article below).

Congress Looking For Votes – Last week Congress passed a bill that is designed to stop the bleeding in the housing market. There is an election coming up and again we have to imagine that the current administration will use whatever tools they have to buoy stocks. It does appear to me the bill has some teeth in it and also there are some signs that some real estate markets are showing increased activity. My work shows the charts of the Housing stocks appear to be ready to rally also.we do believe these band-aids put to work by the government may have some short term effects, but in the long term they may be negative for the deficit, the dollar, and the economy?

We are reprinting the table that shows the Secular Bear Market rallies that occurred during the Depression. As you can see it paid off to be invested in stocks during these periods. What is interesting to keep in mind is that every one of these rallies gave back the entire rally in subsequent corrections. The “Buy and Hold” strategy did not work during that period.

BEGIN	END	DURATION	RETURN
Nov. 13, 1929	April 17, 1930	6 Months	+ 48%
July 8, 1932	Sept. 7, 1932	2 Months	+ 94%
Feb. 27, 1933	Feb. 5, 1934	12 Months	+ 121%
July 26, 1934	March 10, 1937	20½ Months	+ 127%
March 31, 1938	Nov. 12, 1938	7½ Months	+ 60%
April 8, 1939	Sept. 12, 1939	5 Months	+ 28%

Although the market may have to consolidate its recent gains and possibly retest the early July lows, it is nice to share a relatively positive commentary regarding stocks. We realize we have been somewhat of a drag recently. A friendly stock market and football season beginning, things are looking up.