Is this the bottom for this market cycle? A lot of people are cheerleading for the market right now, saying that the bottom is in place and that the Bear Stearns
(BSC)
buyout is the cataclysmic event that tells us the worst is over.
The market is up over 100 S&P points, with almost all of the gains coming in just the last week. There seems to be powerful buying in the market, and it seems easy to say, "This is it, everybody in the pool."
I would love to jump in here, and I confess I am tempted. But there is little voice in my head that is yelling at me to realize that this would be the most forecasted and widely recognized market bottom in the history of the stock market. I am also somewhat skeptical that what the worst financial crisis since either the early 1990s or the 1930s, depending on who you talk to, is over in less than nine months, with a peak-to-trough decline of just about 25%. I seem to recall that the collapse of the Internet boom resulted in a drawdown of better than 50%, even as the Fed lowered rates and GDP growth was positive.
I also recall that after the initial market break in 2000, the market rallied to new highs in both 2001 and 2001 before collapsing to new lows. In 2002, the Dow rallied about 30% before collapsing back to the low. The lows came when everyone was scared to death and pulling money out of the market.
I was a broker at the time, and it was easier to sell communicable disease at that time than it was to convince someone to put money to work in the stock market. The phrase of the day was not "buying the dips"; it was "only dips are buying." No one anywhere wanted anything to do with the stock market. Money flowed back to the banks for the fist time in over 10 years as investors sought security and safety over equity returns.
I do not see that type of fear or even just apathy at this point. I have a very strong suspicion that this is one of those bear market rallies that starts with short-covering and ends with I-have-to-get-back-in-now buying, followed by an enormous amount of financial pain in the weeks and months to come.
The market has become extraordinarily Fed-focused, in my opinion. Every new Fed action is greeted by enthusiastic buying as the government comes to the aid of the stock market. It does not appear, however, that anyone is paying attention to what the Fed has actually done. It is unprecedented and more consistent with staving off a depression than with just ending a bear market.
Since August of last year, the central bank has created three new ways to borrow reserves without going to the Fed window. This allowed banks to borrow money without actually admitting to the public how much they borrowed or how bad their balance sheets had become. Next, they opened up the window to investment banks. This had not been done since the Great Depression!
The Fed is making markets in mortgage-backed securities and seemingly functioning as an investment banker in the Bear Stearns-JPMorgan
(JPM)
deal. Monday's price increase by JPMorgan in the offer for Bear, with continued backing from the Fed, smacks of desperation to me. I still maintain that it will pay whatever price it takes to keep that balance sheet and those counter-party arrangements out of the public eye.
The rally in homebuilders today was laughable. The existing-home sales increase of 2.9% was widely cheered, and the stocks were very well bid, breaking out to six-month highs. The chartists were delirious and suggesting it was time to buy. No one talked about the better than 8% drop in home prices, the largest drop since 1968!
There is still nine months of inventory on the market, and more foreclosures are coming into the marketplace every day. According to a report from Merrill Lynch, aggregate mortgage debt is now more than total home equity in the U.S., and at least 9 million homeowners are upside down in their houses. We are nowhere near a bottom in housing, and the builders are a sell, not a buy.
Right now in the July 2008 options on the iShares Dow Jones US Home Construction ETF
(ITB)
, I can set up a bearish put spread ( I am a chicken short -- I like to limit my potential losses) using the 20 and 15 strikes at least a risk-to-reward ratio of 2.5 without working the bid-ask spread. I will be putting orders in to try and get inside the spread and put that trade on.
I want to be bullish, I really do. But this feels like a bear market rally to me. The Fed seems to have been acting in an almost desperate fashion in the last three months, and I have to wonder what has it so scared. Whatever it is cannot possibly be good for stock prices.
At the time of publication, Melvin had no positions in stocks mentioned, although positions may change at any time.Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.
