This blog post originally appeared on RealMoney Silver on March 27 at 8:29 a.m. EDT.
In " It Ain't Heavy, It's a Bottom," I outlined a variant view that the U.S. stock market was not only making a yearly low but, quite possibly, a generational low. Today it might be difficult to remember the degree of pessimism that existed during those dreary early days of March as the S&P 500 hit 666 on the very day of my bottom forecast, which I openly declared on "The Kudlow Report." Also in "It Ain't Heavy, It's a Bottom," I coupled my investment rationale (the mosaic of fundamentals, valuation and sentiment) with what I saw as some solid parallels between 2008-2009 and the 1937-1939 interim interval. That led me to a specific forecast for the S&P, which was presented in the SPDRs ( SPY) chart below.
A poorly positioned hedge fund community, with an historically low net long exposure and rankled by negative investment returns and the fear of continued redemptions, should provide the initial thrust to the S&P's 50-day moving average of about 810. It is important to recognize that, historically, strong rallies that have durability (like in 1937-1938) typically, as previously written, don't let investors in during the first advancing leg. With such a clear burst of momentum, the fear of being out could drive the S&P 500 as much as 15 to 40 points above the 50-day moving average, paralleling the 20% third-quarter 1938 move and producing a short-term top and a temporarily overbought market.Subsequently, the S&P 500, only three brief weeks from my bottom call and remarkably on cue, advanced like a rocket to the 50-day moving average, which by then had declined from about 810 to 803. Since then, my expectation that the market would move as much as 15 to 40 points above the moving average, as investors would move from being fearful of being in the market to fearful of being out of the market, has been realized as well, with a precision that even baffles this writer. I went on to write, with a continued eye toward a precision of forecast, my view that we would see some backing and filling following the market's sharp initial thrust.
The spring should be characterized by a backing and filling as the sharp gains are digested, similar to the September-October 1938 interval. Sloppy second-quarter warnings will weigh on the market during the April-May period, but the markets could move sideways, bending but not breaking. Signs of market skepticism, sequential economic growth and evidence of a bottoming in the residential real estate and automobile markets (after a sustained period of under-production) could contain the market's downside, providing a range-bound market with a firm bid on dips. As well, the results from the bank stress tests and the release of a more coherent and detailed bank rescue package could provide further support to equities.I continue to use the template of 1937-1939 as a parallel to the 2008-2009 economy and stock market.
- The stock market decline followed a four- to five-year rally, after a three-year decline of greater than 80%, which is similar to the Nasdaq experience.
- Worldwide industrial production collapsed in 1937.
- Commodities crashed in 1937.
- The markets spent five years consolidating the declines.
- Massive government spending pulled the U.S. out of The Great Depression. (Back then, it was preparing for WWII; this time, it will be government stimulus/infrastructure.)
- Leg one of the 1938-1939 rally was brief and intense; it lasted only about 12 trading days, and the indices rose by 19%, which is very similar to the recent intense rise.
- Leg two was an approximate 60-day consolidation that corrected half of the initial gain; we may be entering that phase now.
- Leg three was about a six-week rise of 30%.
- Leg four consisted of another two-month consolidation and retracement followed by a 22% six-week rally, serving to mark a multiyear high in the averages. I continue to expect this final leg in mid to late summer 2009.
By June, economic traction should begin to take hold from the accumulated fiscal and monetary stimulation coupled with the large drop in energy prices. While it will be too early to demonstrate a broad economic recovery, evidence of stabilization will be clearly manifested in improving retail sales, and stocks will take off for their final advancing phase. With fixed income under increasing pressure, large asset allocation programs at some of the largest and late-to-the party pension plans (out of bonds and into stocks) could trigger an explosive rally in the middle to late summer. This move by July or August could close the October 2008 gap in the SPDRs at around $107.
Doug Kass writes daily for RealMoney Silver , a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.
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