We're Not Out of the Woods Yet

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 - commentary - Cramer's Take) 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!

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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.