WSJ: Was It A Sucker's Rally?

The Dow Jones Industrial Average has bounced an astounding 30% from its March 9 low of 6547. Is this the dawn of a new era? Are we off to the races again?

Only a fool predicts the stock market, so here I go.

I'm not so sure. Only a fool predicts the stock market, so here I go. This sure smells to me like a sucker's rally. That's because there aren't sustainable, fundamental reasons for the market's continued rise. Here are three explanations for the short-term upswing:

1) Armageddon is off the table. It has been clear for some time that the funds available from the federal government's Troubled Asset Relief Program (TARP) were not going to be enough to shore up bank balance sheets laced with toxic assets.

On Feb. 10, Treasury Secretary Timothy Geithner rolled out another, much hyped bank rescue plan. It was judged incomplete -- and the market sold off 382 points in disgust.

Citigroup stock flirted with $1 on March 9. Nationalizations seemed inevitable as bears had their day.

Still, the Treasury bought time by announcing on the same day as Mr. Geithner's underwhelming rescue plan that it would conduct "stress tests" of 19 large U.S. banks. It also implied, over time, that no bank would fail the test (which was more a negotiation than an audit). And when White House Chief of Staff Rahm Emanuel clearly stated on April 19 that nationalization was "not the goal" of the administration, it became safe to own financial stocks again.

It doesn't matter if financial institution losses are $2 trillion or the pessimists' $3.6 trillion. "No more failures" is policy. While the U.S. government may end up owning maybe a third of the equity of Citi and Bank of America and a few others, none will be nationalized. And even though future bank profits will be held back by constant write downs of "legacy" assets (we don't call them toxic anymore), the bears have backed off and the market rallied -- Citi is now $4.

2) Zero yields. The Federal Reserve, by driving short-term rates to almost zero, has messed up asset allocation formulas. Money always seeks its highest risk-adjusted return. Thus in normal markets if bond yields rise they become more attractive than risky stocks, so money shifts. And vice versa. Well, have you looked at your bank statement lately?

Savings accounts pay a whopping 0.2% interest rate -- 20 basis points. Even seven-day commercial paper money-market funds are paying under 50 basis points. So money has shifted to stocks, some of it automatically, as bond returns are puny compared to potential stock returns. Meanwhile, both mutual funds and hedge funds that missed the market pop are playing catch-up -- rushing to buy stocks.

3) Bernanke's printing press. On March 18, the Federal Reserve announced it would purchase up to $300 billion of long-term bonds as well as $750 billion of mortgage-backed securities. Of all the Fed's moves, this "quantitative easing" gets money into the economy the fastest -- basically by cranking the handle of the printing press and flooding the market with dollars (in reality, with additional bank credit). Since these dollars are not going into home building, coal-fired electric plants or auto factories, they end up in the stock market.

A rising market means that banks are able to raise much-needed equity from private money funds instead of from the feds. And last Thursday, accompanying this flood of new money, came the reassuring results of the bank stress tests.

The next day Morgan Stanley raised $4 billion by selling stock at $24 in an oversubscribed deal. Wells Fargo also raised $8.6 billion that day by selling stock at $22 a share, up from $8 two months ago. And Bank of America registered 1.25 billion shares to sell this week. Citi is next. It's almost as if someone engineered a stock-market rally to entice private investors to fund the banks rather than taxpayers.

Can you see why I believe this is a sucker's rally?

The stock market still has big hurdles to clear. You can have a jobless recovery, but you can't have a profitless recovery. Consider: Earnings are subpar, Treasury's last auction was a bust because of weak demand, the dollar is suspect, the stimulus is pork, the latest budget projects a $1.84 trillion deficit, the administration is berating investment firms and hedge funds saying "I don't stand with them," California is dead broke, health care may be nationalized, cap and trade will bump electric bills by 30% . . . Shall I go on?

Until these issues are resolved, I don't see the stock market going much higher. I'm not disagreeing with the Fed's policies -- but I won't buy into a rising stock market based on them. I'm bullish when I see productivity driving wealth.

For now, the market appears dependent on a hand cranking out dollars to help fund banks. I'd rather see rising expectations for corporate profits.

Comments

[Andrew Butter]

This fool can:

http://www.marketoracle.co.uk/Article9658.html
http://www.marketoracle.co.uk/Article10604.html

Have a check in six months time.

[robert e. gillespie]

add to this: THE NON-EXISTING REAL ESTATE RECOVERY
that started all this...

the BIG PROBLEM...

historically, Real Estate, like most other INVESTMENTS has been CYCLICAL...but NOT THIS TIME... here's why...

1. "Buying a House" as opposed to renting has been a "sweet deal" for many decades in MOST MKTS.

this is because you put 20% down (or less) and if your house appreciates just 10% a year...well, on a 200,000 dollar house YOU WOULD BE MAKING A 50% return on your investment.

(20% x 200,000 = 40,000 which is your down-payment investment)

(10% appreciation in the annual value of your house x 200,000...means you made a "50% gain on your investment!)

You did much better than MOST DO IN THE STOCK MKT OR OTHER FINANCIAL MKTS...and with CONSIDERABLY LESS RISK!

however, this is a DOUBLE-EDGED SWORD...when Real Estate depreciates YOU LOSE your down payment RAPIDLY and in most cases permanently unless the mkt recovers.

Let's say your house went down 20% (or more) in value over the last two years (typical in many mkts) now because of REVERSE LEVERAGING you have lost your entire 40,000 equity in the house if you have to sell (that's why the bank wanted your 20% in the first place...so if there is a REASONABLE DOWNTURN...they are protected until your SECURITY DOWN-PAYMENT is exhausted.

Now, in most Real Estate Cycles...housing doesn't depreciate that much, so in the next up cycle you recover...but not likely THIS TIME!

WHY: tens of thousands of high-paying tech jobs are going overseas to places like India...so there are less and less high-paying jobs to support a recovery THIS TIME.

there is a glut of housing (many empty) because of overbuilding...because everyone saw the "rapidly rising prices" of residential or rental real estate and wanted a piece of this HIGH RETURN, LOW RISK investment...add to this the banks relaxing credit standards and issuing mortgages...because, hey, real estate just keeps going up, up, up...and with that leverage, etc.

well, it all collapsed, and now we have a glut of houses, AND GUESS WHAT...

WHY WOULD YOU BUY A HOUSE THAT IS GOING TO "DEPRECIATE IN VALUE because of the "negative leverage factor," even if you can GET A MORTGAGE AT 2%...YOUR STILL LIKELY TO LOSE YOUR DOWNPAYMENT...(better to Rent, and put your money in Gold or some other prospective investment...and rents are coming down because of the glut of housing...plus the impact of renters being evicted because of job loss, etc.

Also, the gov is NOT GOING TO ALLOW THE BANKS to pump up the Real Estate bubble AGAIN with risky loans...

So, essentially REAL ESTATE, though IT MAY BE NEAR THE BOTTOM, is NOT GOING TO RECOVER anytime soon, if ever...

In fact Real Estate will MOST PROBABLY...CONTINUE TO DECLINE...

just because the losses in home values are slowing DOES NOT MEAN THEY WILL REVERSE...

think about it...

why buy a house, even at a 2% (or less mortgage) IF YOU ARE GOING TO LOSE YOUR DOWN-PAYMENT...

do the arithmetic...most buyers will...

SO THE SPIN HOOPLA on WALL ST. about a Real Estate Recovery is UTTER NONSENSE...

show me how, why and the way...

don't show me incremental statistics showing a slowing in decline,
or slightly positive numbers in specific mkts...

some people will always have money to buy a BMW...problem is there are a LOT LESS OF THEM BUYING A BMW...

flashrob

[Alexander Kolpakov]

Good point, Mr. Gillespie, thank you, and let me add that commercial Real Estate in US is in the same mess.

[Howard]

You people are too simplistic in your thinking. Most of the places with the massive overbuilding selling at inflated are not even places where most people want to live. Location, location, location still rules. Will real estate eventually recover? Absolutely. Rhetoric about renting as the only sane thing to do...clearly written by someone who doesn't own his own and never will.

Sure, jobs have gone overseas...but, in this big cluster-f*ck we've been through, you're going to see a big change going forward. The outsourcing of jobs overseas was entirely based on a cost savings thesis - which no longer holds. You have many, many professionals now on the sidelines who will come back in to the workforce and be willing to accept a lower paycheck in the near-term. This, coupled with the ability to have employees physically with you eliminates the cost differential and many of the problems that have come along with outsourcing. India and similar body-shop countries that were hotspots for outsourcing are going to be in some serious trouble, because if the cost differential is reduced or eliminated, they have no other way in which to compete. T's surely not on the basis of quality or the level of service they provide.

And I absolutely guarantee you, Wall St. is not dead. There will always be the next complex structured newfangled product or grand idea some brainiac comes up with that will take things into the next cycle. Real estate will always be boom or bust. We always have the biotech cycles. We had energy trading. Then all these "toxic assets" backed by MBS, CDO, CDS, and so on. Wall St will always have something to pitch and there will always be suckers rushing in to drink the KoolAide.

Your theories are simplistic at best.

Whenever someone says "well this time it's different" he is generally wrong - whether with the market continually going higher...or lower.

[Jeff]

Andy- please delete the SPAM post in the comments (It is the first post... something about market oracle)
SPAM is obnoxious

[Brian]

The FairTax, one of the best as well as most misunderstood ideas to come along in years, would generate much more revenue for government coffers.

Speaking of India, China, and etc, many more companies would remain in country instead of moving out. Companies that have moved would return.

The FairTax is investor friendly, since there is no penalty for success, plus business will not have to plan their actions based upon tax consequences.

[KOBV Pöchlarn]

My association and the Local Pöchlarn KOBV of advice and support for disabled people, see how it does for you from your country in your way. If you fancy you visit my site would be glad.
nice greetings from Austria to the Chairman of KOBV Pöchlarn

[Lucas DuVal]

Thanks Andy. You are the greatest at putting everything in perspective. I was bordering on optimism for about two months.

Loyally yours,

LUKE

[mr big dicks hot chicks]

For now, the market appears dependent on a hand cranking out dollars to help fund banks. I'd rather see rising expectations for corporate profits.

[WhitleyMollie19]

Set your own life more easy get the personal loans and all you need.