Insights & Advice

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The Stimulus Bill—Why the Markets don’t Care

You would think that the largest stimulus package in American history might have provided a wee bit of cheer to the stock market this week. Instead, the markets moved lower with the Dow and S&P500 down over 5% while the NADAQ was off 3%. The Dow, in particular, is less than 300 points from its November, 2008 low.

Cynics argue it was simply a classic “buy on the rumor, sell on the news” event. I’m not so sure.

The fundamental issue for the stock market continues to be the continuing deterioration within the financial sector. Nothing the government did this week assuaged that concern. The market began to sell off on Tuesday even before Tim Geithner, the president’s newly-appointed U.S. Treasury Secretary, made his debut appearance. The much-heralded bank rescue plan he unveiled contained little in the way of new initiatives or approaches. Disappointed investors promptly sold the markets down almost 5%. Since then the averages have barely been able to hold Tuesday’s levels.

Investors are convinced that unless the government can truly fix what ails the financial system no amount of money in the world will move the economy forward. This line of reasoning leads us back to the still-declining housing market, sub-prime loans and the trillions in toxic assets that bedevil our banks. There is also another shoe to drop in the form of commercial real estate loans that will have to be dealt with this year. I believe that until we can come up with a viable solution to these problems the markets will continue to move lower.

Now that may not occur in a straight line. We continue to have powerful counter rallies based largely on government interventions—bail-outs, interest rate cuts, stimulus packages–but my downside target for the S&P500 index (the benchmark I use) continues to be 680. That is substantially lower than the present level of 826 (about 17%). I’m not calling a market bottom at that level but simply a first stop. We could go lower and we will if things get worse within the economy and the banking sector.

We will also experience bear market rallies. These are designed to suck in those investors who were smart enough to move into cash or bonds sometime last year or even earlier. Many of these investors are itching to get back in and call me continuously. It is always the same question.

“How do you know the difference between the real bottom and a bear trap?” asked one such client who is in cash and driving himself crazy trying to pick a market bottom.

One sure indication of a bear trap is watching which sector leads the markets higher. In every bear market there is usually a sector that causes the collapse. In 2002-2003 it was the tech sector. Back in 1982 it was the oil sector. In this bear market it is the financial sector. Markets continue to correct until everyone throws in the towel on the problem sector. Since this bear market began back in November of ‘07 just about every move up has been led by the financial sector. Some hopeful rumor or new government intervention would spark a rally among the financials. The markets would move higher and then the inevitable disappointment would follow. Everyone attempts to sell at the same time and you know the rest.

I have lost count of the number of times this has occurred (at least a dozen) in the past year. So if banks are leading or at least participating in the upward move, long-term investors should step aside stick with cash, bonds or other income investments… If you are a short-term trader and think you can outsmart the pros then jump in but buyers be warned. The volatility in these markets makes anything but long-term investing a huge gamble. It also demands your attention 24/7 so don’t get a day job.

Markets have become so treacherous that given the holiday on Monday, few participants are willing to carry any positions, long or short, for three entire days. There is a G-7 meeting this weekend as well. Some traders speculate there could be some new announcement during that forum. On Tuesday, depending on the news, the roulette wheel we call the stock market begins to turn once again. Round and round it goes, in what direction no one knows.

Posted in A Few Dollars More, At the Market