Here's the way I read the market right now and why it is important to you:After a series of devastating single down days for the stock market since la...
Here's the way I read the market right now and why it is important to you:
After a series of devastating single down days for the stock market since last fall,
we had an unbelievable rally of 379 points, or six percent, on Tuesday. Yesterday, instead of the market giving back that gain, it held its own. This is very impressive, as the usual profit taking that has followed rallies over the past few months didn't happen yesterday.
The number of short sellers in the market is near a record high. Shorts make money by betting that stocks will decline. But, if stocks start to rise and the shorts need to cover, this just sends stock prices higher. There is also trillions of dollars on the sidelines ready to jump into stocks if the market looks like it is coming alive. Stocks are severely oversold (see "Where the Market Stands" below).
After being involved with stocks for almost 30 years, and after studying the markets for more years than I care to admit, I've come to the conclusion that bull markets end at extremely speculative points (stock valuations in excess of 20 times, dividend yields of two percent) and bear markets end when they are exhausted (when valuations are below 10 and dividend yields are at six percent).
Stocks are nowhere near great values today. But remember, my dear reader, nothing goes up in a straight line or comes down in a straight line. All bull markets have down periods on the way up. All bear markets have rallies on the way down.
If stocks move higher over the next several days -- and there is a good chance they could -- we may have the makings of a classical bear market rally that is not only tradable, but that could also deliver some great stock profits. A rally in the confines of a big picture bear market can last weeks, if not months.
** Michael's Personal Notes:
Who was the biggest winner when the market rallied on Tuesday? None other than the Dow Jones U.S. Home Construction Index. The index, which hosts the largest American homebuilders, actually did a rare "gap up" on Tuesday. The index rose an impressive 16% in a single day. Is it severely oversold or are things turning around for homebuilders? Time will tell. There are millions of empty homes in the U.S. and that will take years to absorb. But, interestingly enough, two homebuilders I spoke to today told me that February was their best month for sales in the past six months.
** Where the Market Stands:
The Dow Jones has lost 7,233 points since its peak in 2007. This index was down 35% in 2008 and is down another 21% so far this year. What worries me the most about this index: if we take the low point of the Dow Jones in the bear market of the 1930s and the high point of the bull market that ended in 2007, the Dow Jones has fallen below the mid-point. In other words, the market today is closer to its low of the 1930s than to its high of 2007.
** What He Said:
"The U.S. lowered interest rates in 2004 to their lowest level in 46 years. And what did Americans do with their access to easy money? They borrowed and borrowed some more, investing the borrowed money into real estate. Looking ahead, perhaps the Fed's actions (of lowering interest rates so low as to entice consumers to borrow more than they can afford) will one day be regarded as one of the most costly errors committed by it or any other banking system in the last 75 years." Michael Lombardi, in PROFIT CONFIDENTIAL, July 21, 2005. Long before anyone was thinking of a banking crisis, Michael was warning that the coming real estate bust would create havoc with the banking system.
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