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One of the most basic technical rules says that sound stock market rallies are accompanied by high and rising volume. By contrast, bear market rallies are characterized by low and falling activity.
Therefore, according to this rule, the rally of the past months has to be treated with great caution. From its beginning in March 2009, it was lacking volume.
As you can see in the lower panel of the NYSE Composite Index chart below, this technical deficiency never healed, and got even more pronounced during the last month.
Source: www.decisionpoint.com
Especially notable and technically unhealthy was the pattern of rising volume during short-term corrections. Sound corrections are earmarked by low and declining volume.
Taken together, the stock market rise off the March 2009 low has the look of a bear market rally … a huge one in fact. You might even compare it to the frightening experience of 1930.
The Bear Market Rallies
Of 1930 and 2009
In 1930, the market rose roughly 50 percent from its 1929 crash low thus recouping half of the preceding losses. This monster rally led many contemporary economists, politicians and financial market experts to reason that the worst was over. But it was not to be …
The Great Depression had barely started, and the stock market suffered losses of another 85 percent measured from this interim high of 1930.
How does the current rally compare to this frightening potential predecessor?
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| There is a scary similarity between the 1930 rally and 2009’s. |
Well, from the March low the S&P 500 has soared 69 percent in nine months. In doing so it recouped a bit more than 50 percent of its former losses. But it’s still 27 percent below its all time high of October 2007.
Yes, the market rallied strongly in 2009. But it did the same thing in 1930. History then tells us that the current stock market rally is not sufficient enough to reason that the worst is over.
In addition, we have to accept the reality that …
The Burst Real Estate
Bubble Is Still with Us
The aftermath of the burst real estate bubble is not over yet. We can expect more bad news, more bad debts, more bank failures, and the bad times to last much longer.
If you aren’t convinced, take a look at what the Treasury Department did on December 24:
In September 2008 the Federal Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac into conservatorship. At the same time Treasury established Preferred Stock Purchase Agreements (PSPAs) to ensure that each firm maintained a positive net worth.
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| Based on its recent action, the Treasury Department does not believe that the real estate crisis has ended. |
Treasury is now amending the PSPAs to allow the cap on Treasury’s funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years. At the conclusion of the three-year period, the remaining commitment will then be fully available to be drawn per the terms of the agreements.
This tells me that the Treasury Department is convinced that the worst of the burst real estate bubble is yet to come. Why else would they be providing unlimited financial support for the two largest Zombie banks the world (outside Japan) has ever seen?
As we move into a new year, the stock market’s technically weak rally and the repercussions of the burst real estate will follow along. So stay flexible with your investment strategy because we could be in for another hard fall.
Best wishes for a Happy New Year!
Claus
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