Is the rally sustainable?
One important thing to remember is that the market and the economy, while related, do not move in tandem. Markets are forward looking, meaning they try to move ahead of the economy. Oftentimes, then, a market recovery signals an economic recovery is a few months ahead. Also, it means that the recession will continue even as the market has bottomed and a recovery -- in the stock markets -- has started. So is this it?
First, let's look at the economy. It seems that almost every day we hear more bad news. Only today, for example, data on manufacturing reached yet another multi-year low. Meanwhile, the job market is deteriorating, with an 8.1 percent unemployment rate that many fear could be over 10 percent by year end. Housing, of course, is nowhere near recovering from the current supply glut. Despite efforts by banks and governments, foreclosures grew by another 30 percent in February. By all accounts, the situation isn't very encouraging.
Economists look for signs of a bottom. For example, the jobs market would signal a bottom when companies start hiring more temporary workers and when hours worked by current employees increase. This hasn't happened yet. For housing, the figure to watch is backlog of unsold homes. Right now, it would take over nine months to clear all the supply. A more normal pace would be six months. So when we see that number starts declining toward its normal pace, which would coincide with less foreclosures, that would signal a housing market bottom. That hasn't happened yet either.
So what has happened? Remember retail sales? These actually increased last month if you don't count autos. Investors may also feel confident the economic stimulus plan could help revive the economy and feel that with mortgage rates so low the housing market should bottom sooner. But investors are looking for turnarounds not just in housing, consumer spending and unemployment among other economic changes, they are also looking in other places, like the financial and commodities markets. And this is where we've seen some real changes of late.
First, the banks. Starting with Citigroup (C)'s announcement last week it was profitable the first two months of 2009, along with similar subsequent announcements from Bank of America (BAC) and JP Morgan (JPM), and then even some good news out of some banks from Europe, it seems the financial crisis, at the very least, may be finally in its (very) initial states of resolving itself. Add to that Geithner's plans for toxic assets and possible mark-to-market rule easing (as well as reinstating the 'uptick rule'), and one of the biggest weights on the market doesn't feel as heavy anymore.
Second, commodities. Prices of commodities have risen recently too. How does that help anything? Well, while some wouldn't be happy about higher gas prices, or grain prices, the fact is it means something. Commodities tend to be somewhat of economic barometers. Recall how commodity prices rose during the last bull run? If commodity prices rise it means there may be more demand, which could mean better days are ahead for production. The question is whether this growth is really fueled by demand or by trader action. The global economy is still in recession and a long-term commodities rally can only be sustained when the recession is over.
As for the market, the increased volume during this rally and the entrance of big institutional investors may indeed indicate a bottom. Of course, with different funds usually holding stock for long-term gain, and as so many big names have sunk so low, they have started to snap up stocks, increasing volume and showing money flowing back into stocks. And let's not forget last week's Big Pharma mega deals too.
Writing this, I almost feel like picking up the pom-pons and start cheering. But if anything, the events in the last year or two have taught us to be cautious. Indeed, we can't ignore sentiments -- and they're not all good.
Banks are still in bad shape, despite all positive headlines lately. OPEC has just decided not to cut quotas and oil has declined again. There is much criticism over Obama's stimulus plan with critics claiming it would not revive consumer spending, and maybe even hurt business. The recession is global and any recovery in the U.S. will depend, to a degree, on recovery in other countries. Not to mention much of the rally has been fueled by short covering and oversold conditions.
Many have been feeling lately the ground was about to drop from under them, but then it seemed things aren't that bad. Or so the feeling goes. Is this then the beginning of a new bull market or just a bear market rally? While only time will tell for certain, starting to nibble away at some oversold stocks may be a prudent move. Even if it is just to test the water.
Who knows, with many nibblers, perhaps the rally will be sustained.