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Stocks New Bull Market Rally or Bear Market Trap?

Stock-Markets / Stocks Bear Market Jul 19, 2008 - 05:45 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: Editor's Note: After stock prices surged strongly on Wednesday and Thursday, we decided to look to see if we could determine whether this was a bear-market trap, or the start of a new bull market rally. Our findings may surprise you.

"Put this bell on your pack.”


The odd-sounding order came from my guide, a lifelong mountaineer and expert tracker who (and I'm not making this up) answered to the nickname, Buck.

This took place several years ago, when I was hiking just outside Cody, WY. I'd been in the area several times, but my companions felt compelled to have me attach one of the little noisemakers to my backpack, and I obliged.

Buck continued to speak, as we got ready to move out.

“It helps to take precautions,” he said. “Also, make sure to carry pepper spray in case you meet a grizzly bear unexpectedly.”

As we started to walk, Buck cautioned me to “watch out for signs that grizzlies are in the area - like fresh bear [droppings].”

“How will I know when I see it?” I asked, not realizing that I was about to “step in” something myself - in this case, a joke that was on me.

“Because,” Buck noted with a wry smile, before turning away to head down the trail, “it'll smell like pepper and have lots of small bells in it.”

There's a reason I'm telling this story (besides figuring you could probably use a good chuckle right about now), and here it is: Being aware of your surroundings is crucial when you're hiking the grizzly-infested mountains of Wyoming - and it's no less important when you're attempting to navigate Wall Street's wilds.

Especially lately.

That's why I wanted to make a special point to the folks who are viewing this week's two-day rally as the potential start of a massive bull-market upswing. And that point is this: None of the factors that we were worried about before the rally have changed or gone away. Nor have any of the other potential pitfalls that we've repeatedly warned you about.

The U.S. Federal Reserve is still scrambling to deflate the asset bubble it created - and is trying to do that in an orderly manner (a mistake on both counts). But the backstory isn't pretty. Banks are still taking big write-offs, and in some cases also are under investigation. And there still are many reasons to be worried about commercial real estate, the U.S. housing market, inflation, stagflation, soaring food and commodities prices, and stratospheric energy costs.

The other thing that concerns us is that the markets tend not to do well when bad news is interpreted as good news - as Citigroup Inc.'s ( C ) latest numbers were overnight. Somehow the Street thinks that Citi's loss of a mere $2.5 billion this quarter is good because it was less than the $2.86 billion of red ink that the Street was expecting.

Let's not forget that the beleaguered banking giant has written off nearly $40 billion in the past 12 months, revenue has fallen 29%, and that it is laying off 15,000 employees.

That brings us to the broader markets, and our belief that rallies like those we've had in recent days are suspect, at best. The data seems to support this.

The bottom line: As much as we wish this weren't the case, the strength we've seen in recent days may be nothing more than a massive short-covering rally. [Interestingly, Money Morning Contributing Editor R. Shah Gilani said precisely the same thing in his “Inside Wall Street” column published earlier today (Friday).]

While it's true that we may have a tradable bottom here that takes us as high as 1,370 or thereabouts on the Standard & Poor's 500 Index (only about a 9% increase from current levels), such numbers are hardly impressive when viewed against the harsh light of history.

For instance, according to our friends at the Bespoke Investment Group , the 150 stocks with the highest short interest are up an average of 15.1% over the last two days (Wednesday and Thursday). Yet, at the same time, stocks with the lowest short interest have climbed a mere 2.2%.

Volume also remains light at 80% of total New York Stock Exchange ( NYX ) up/down volume, and well short of the 90% up day that typically accompanies real reversals, and which has historically represented the foundation of sustainable bull rallies. In addition, in crunching numbers last night (Thursday), we see no evidence that institutions are accumulating shares, which is, of course, something else that typically happens when the bulls come out to play in earnest.

Technically speaking, we've seen the Chicago Board Options Exchange Volatility Index - usually referred to as the VIX Index , and generally regarded as a proxy for fear in the markets - move higher as the markets have moved lower. But just prior to the rally, it was nowhere near the high levels that have characteristically preceded the serious reversals that fuel new bull markets [ Editors' Note : For a recent Money Morning research report on “market bottoms” that explains this reversal concept in deeper detail, please click here .]

All of which suggests, once again, that while we may see a “dead cat bounce” for the next little while, there is ample room for another melodramatic move to the downside.

Boy do we hope we're wrong.

[ Editor's Addendum : If the whipsaw markets we're experiencing lead to the so-called market “SuperCrash,” shrewd investors will be able to capitalize on once-in-a-lifetime profit plays . For a free report, which includes a free copy of CNBC analyst Peter D. Schiff's New York Times bestseller, " Crash Proof: How to Profit from the Coming Economic Collapse ," please click here .]

News and Related Story Links:

By Keith Fitz-Gerald
Investment Director

Money Morning/The Money Map Report

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