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Fundamental Reasons Why the Stocks Bear Market Will Return

Stock-Markets / Stocks Bear Market Apr 10, 2009 - 01:59 PM GMT

By: Money_and_Markets

Stock-Markets Diamond Rated - Best Financial Markets Analysis ArticleSean Brodrick writes: After four weeks of gains, the market has been on a slippery slope this week. Still, we could see stocks rally though the end of this month or even longer. But the bear is out there, my friends. Here are seven reasons why …


Reason #1: The Banking Crisis Still isn't Fixed … It's Getting Worse!

The U.S. government has allocated at least $356 billion bailing out the banks alone. Most of that has been thrown down a rat hole. For this same amount of money, 10 new banks could have been chartered with $35 billion each and they could have loaned out funds at 10-to-one leverage, creating $3.5 trillion of new financial muscle.

Instead, we're spending hundreds of billions to make sure that AIG executives get their bonuses and Goldman Sachs, JP Morgan and all the other financial institutions that were counter party to AIG's enormously bad trades get paid off in full. In short, the Obama administration, rather than chart a new course to fiscal sanity, is intent on re-inflating the bubble.

And how is it getting worse? The International Monetary Fund (IMF) just announced that toxic debts could reach $4 trillion, up from an estimate of $2.2 trillion that it made in January.

I gave you the run-down on how cronyism is hijacking the bank bailout in last week's Money and Markets column, titled: “Financial Terrorism and You.” I also gave you updates on my blog that show how conflicts of interest for Obama's top financial advisors make them inappropriate choices to deal with this crisis.

Then just yesterday, news came out that made me want to pound my head on my desk until I could slip into blissful unconsciousness. The Financial Times tells us that U.S. banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets from other banks. So what's to prevent all these banks from overpaying for each other's assets with our money … overpayments that would leave Uncle Sam holding the bag?

Absolutely nothing that I can see.

If we don't address the core problems of the financial crisis — companies that got “too big to fail” while at the same time stretching their treacherous tentacles throughout the halls of power in Washington — this problem will NEVER go away.

Reason #2: Job Losses are the Worst Since the Great Depression

The March employment report saw nonfarm employment drop by 663,000 and the unemployment rate rise to 8.5 percent. Now, bulls will tell you that job losses and unemployment are both lagging indicators. True. But as this chart shows, the pace of job losses is worse now than in the past five recessions …

Job losses in six recessions

Source: Time.com

Nonfarm employment has dropped by 5.1 million, or 3.7 percent, since its peak in December 2007. In the 1981-82 recession, employment fell 3.1 percent, and in 1974-75 it fell 2.8 percent. In fact, the only time that America shed jobs faster was during the Great Depression, when a third of all nonfarm jobs disappeared.

Making matters worse, according to a recent poll, more than 6 in 10 Americans are concerned that someone in their household might lose his or her job in the next year. We haven't seen the bottom in the job market, and until we do, a pall of fear will probably hang over the economy and the stock market.

Reason #3: The Deleveraging of the U.S. Credit Bubble Has Already Begun. And It isn't Pretty …

Job losses in six recessions

Source: Contraryinvestor.com

Household deleveraging is just starting, and it's going to get ugly. Consumer wealth is evaporating like water in the desert.

The Fed reported in March that households lost $5.1 trillion, or 9 percent, of their wealth in the last three months of 2008. That's the most ever for a single quarter in the 57-year history of record keeping by the central bank. For the full year, household wealth dropped $11.1 trillion, or about 18 percent. That's the largest decline EVER recorded.

So Americans are feeling poorer, with good reason. Is this the kind of environment where people open up their wallets and spend?

Heck no! It's the kind of environment that could suck a trillion dollars a year from the U.S. economy.

Reason #4: Credit Cards are Imploding

Banking analyst Meredith Whitney — who called the bank bubble quite loudly (along with our own Martin and Mike) when many others ignored it — was forecasting that nervous bankers would eliminate at least $2 trillion of available credit on credit cards by the end of next year. That was six months ago. Now, she thinks she underestimated the cutback and has revised the number to $2.7 trillion (about half of available credit). The effect of those cutbacks on already anxious consumers is bound to be enormous.

Reason #5: It's Probably WA-A-A-AY Too Soon To Call a Bottom in the Housing Market

Seriously Deliquent Loans by Risk Category

Source: Calculated Risk

You'll notice that the number of seriously delinquent loans was accelerating through the fourth quarter. What's more, the S&P/Case-Shiller 20-City Composite Home Price Index for January fell 19 percent compared to the same month a year ago, reflecting an acceleration from the 18.6 percent year-over-year decline reported for December.

And the problem is likely to get worse …

Some 700,000 homes across the country stand in what's called a “shadow inventory.” These are houses that have been taken back by banks but not yet given to a real estate agent to sell.

Here's another frightful factoid: U.S. home prices have never bottomed while unemployment is still rising. And as I showed you in reason #2 above, we haven't seen the high tide in job losses yet.

Bottom line: We won't know we've hit bottom in the housing market until after the fact. And it will take months, maybe years, for the housing market to work off its problems.

Reason #6: It's a GLOBAL Recession

When Japan slid into its economic “lost decade,” the rest of the world kept chugging along, which was a factor in pulling Japan out of its rut. Today, the World Bank says global economic growth will slow this year by far more than previously estimated, thus sending the global economy into its first contraction — a drop of 1.7 percent — for the first time since World War II.

While the World Bank expects developing nations to keep growing — at a much slower pace — the decline in GDP for developed nations in the Americas and Europe will be sharp and painful.

In a separate report, the Organization for Economic Cooperation and Development (OECD), which includes the United States and other industrialized powers, estimated that the economies of its 30 member countries would shrink by an average of 4.3 percent this year. At the same time, the OECD predicted that global trade would shrink by more than 13 percent.

One final point: We are only one year into the current crisis. After the crash of 1929, the world economy continued to shrink for three successive years, and world trade is falling much faster now than in 1929-30.

Reason #7: The Market is Bearish Until Proven Otherwise

With all the bearishness I've just listed, where is the bullishness?

In the price …

The S&P 500 and Dow are way off their lows. Nonetheless, we've seen big upward swings in this bear market only to see them crushed later on.

Standard & Poor's 500

Source: The Chartstore.com

This rally is one of the biggest yet. But so far, the onus is on the bulls to prove it's real.

According to The Big Picture blog, the only times we have ever seen the stock market surge close to this much in such a short time frame were:

  • December 1929
  • June 1931
  • August 1932
  • May 1933
  • July 1938
  • September 1982

Only September 1982 and May 1933 saw the beginnings of new bull markets.

Earnings season officially started yesterday with Alcoa, but it really kicks off next week. For the S&P 500, analysts are expecting earnings will decline 37 percent from the year-ago period. All 10 groups in the S&P 500 are expected to show a year-over-year decline in profits; that hasn't happened in the 10 years Thomson Financial has been tracking this data.

In sum, fundamentals are terrible, and they haven't improved enough to justify this rally. What's more, the market is overbought. So does that mean I think it's time to get short? Not really — the market can get a lot more overbought. One thing that could drive prices higher is that so many Wall Streeters remain cautious. And if S&P 500 companies start beating drastically lowered expectations, we could run all the way to 1,000 or higher on the S&P 500.

In fact, the market may get even more overbought and overextended, as we saw in the market ‘recovery' of 2004-2006 when the U.S. equity indices were managed up to new highs. At the same time, the rot in the real economy spread, crumbling the foundations of wealth.

Regardless, the market for natural resources could lead any recovery …

For instance, China's copper imports in the first two months of 2009 were up 71 percent from last year. Many copper insiders think there is value in the sector. Charlie Sartain, head of Xstrata's copper division, told Bloomberg that his company is now looking to buy smaller producers whose stock valuations have collapsed over the last 18 months.

So, while I'm not looking for a sustained market recovery — natural resources may be bumping along a bottom.

How to Trade a Trader's Market …

This is a trading rally — don't get married to positions and try to ride the market's swings up and down.

You can go bullish and bearish on the S&P 500. On the bullish side, consider an exchange-traded fund like the S&P 500 Depository Receipts (SPY). You also might consider a leveraged ETF — a fund that aims to track at least twice the performance of its underlying index. A good example is the Ultra S&P 500 ProShares (SSO).

And when you think the markets are ready to head back down again, you can use the ProShares UltraShort S&P 500 (SDS), which aims to track twice the inverse of the S&P 500.

The leveraged funds I've mentioned, both long and short, can deliver outsized returns, but they also carry twice as much risk. I think you'd be foolish to play them without using protective stops. Also, have your profit target in mind when you buy them and stick to it.

IMPORTANT NOTE: At the end of this month, I'll be saying “goodbye” to Money and Markets , and writing only for UncommonWisdomDaily.com , where our focus will be natural resources and international investment opportunities. I have a new video there every Tuesday and a new column every Friday. Be sure to check us out. Writing for Money and Markets has been an honor and a privilege. I hope you'll sign up for my weekly column at UncommonWisdomDaily.com .

All the best,

Sean

This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com .

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