Four Reasons Why This is Still a Sucker's Rally

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26 October 2009. The bulls have complained that the doom-and-gloom crowd have been harping on about a sucker's rally. They speak derisively about perma-bears and stopped clocks being right twice a day. They can point to a series of seemingly false predictions since the rally that thundered the markets off their March lows. Hell, we even asked in June if the stock market rally was over.

Clearly we got the timing wrong on that one. When the 50  and 200 Day Moving Average (DMA) cross each other, it can go either way. We thought the Dow Jones Industrial Average (DJIA) probably go down, instead it went up.

Calling the timing is not our strong point, nor is technical analysis - for which we normally call on friends of the site. After all, we are EconomyWatch.com and not MarketWatch.com. We are focused on the bigger picture.

And the bigger picture still says that this is a Sucker's Rally.

Its as simple as that. The rally is going to end, and there is going to be much wailing and nashing of teeth as markets collapse. Again.

Purely based on funadementals, another crash would be due in the fourth quarter. However optimism tends to build towards the end of the year, and may not be bullish enough yet to tip us over. So the first quarter of 2010 may be a better call.

But why are we so sure the sucker is still on?

Here are four reasons to ponder.

1. The economy is still in crisis.

How can it be when everyone is exuberant again? Well, you should instead ask, how can it be right to be exuberant when the economy is still in crisis? Look at GDP, housing, consumer spending, debt and of course unemployment, and you will see a sickly economy.

Most economists blithely accept US government statistics without remembering history or performing their own due diligence. If they did, they will remember that successive governments, including both Republican and Democratic ones, have tampered with the way that official figures are reported. If unemployment were reported as it was in the 1930's, the figure would already be over 20%. In other words, it is already in depresison-era levels, and will get worse. We will write more extensively on this topic soon.

2. Lower revenues but higher profits is not a stable basis for a recovery.

Take a look at Yahoo. Analysts got wide-eyed with excitement because the company beat Q3 2009 forecasts and posted strong growth in profits. Brokerage houses rushed to upgrade their targets, analysts gushed at the new 'operational efficiencies' in place and the stock hit new highs.

But if you looked closer, the real news was that revenue was down 12% from last year. They had earned blowout profits from steep cost-cutting. Steep cost-cutting usually involves sacking people. Hundreds of thousands of people in the US are being sacked every month, to add to the millions already on the heap.

Over 20% of adults in the United States don't have jobs or are doing seasonal or part-time work. Far from trumpeting a recovery, the Q3 earnings reports are re-inforcing the fact that the only way to book a profit is to sack people. But eventually there is no more costs to cut, because there is no-one left to sack. What then?

3. This happened before - during the Great Recession.

There is a scary similiarity between what is happening now and what happened in the Great Recession. In 1929, the market fell about 48%, only to rise 48% again in the 1930 rally. It was then 20% below its peak. You can be sure that the bulls were crowing and lambasting unpatriotic bears.

What happened next? From the April 1930 mini-peak, the DJIA dropped over 80%, or 89% from the 1929 high. It took 25 years to get back to that level.

Now, we don't think markets will drop that far down. The vast Fed and Treasury actions taken have been designed to protect the markets even at the expense of the longer-term health of the economy. But there is a limit to what cheap money can do.

4. The DJIA has formed a bearish rising wedge pattern

Our technical analysis advisor, Simon aka Futures 168, has been pointing out for several weeks that the DJIA along with several other major indices have been forming strong rising wedge patterns. According to StockCharts.com, the rising wedge is a bearish reversal pattern that forms during a bullish period. Prices are rising, with higher highs and higher lows, squeezing towards the top and eventually leading to a sell-off. This pattern also indicates a denouement within the next 6 months.

 

The DJIA Forms a Bearish Rising Wedge Pattern

 

 

Of course nothing is certain when it comes to the markets. Stocks might defy fundamental logic as cheap money keeps up the illusion of growth. Whenever there are signs of spluttering, more cheap money and ever greater relaxing of regulations may be used to accommodate another false leg of growth.

But eventually this shoe drops, just as it has done in Japan.

Even if you are optimistic by nature, you should make sure you are diversified in your portfolio, and have a plan for when gravity finally takes hold again.

Juan Abdel Nasser

EconomyWatch.com