How Much Higher?

Before I get to the market forecast for the week, just a quick reminder that this IS a bear market rally, and once it ends:

• "Too-big-to-fail" banks like Bank of America andCitigroup, and corporations like Chrysler and General Motors, WILL ultimately be allowed to fail; their shareholders will be essentially wiped out andtheir creditors will have massive losses.
  
• In the stock market, the bear market rally we've seen will end; the financial stocks will give up all their gains and the broad averages will plunge to new lows.
  
• Credit markets will freeze up again, the government's stimulus package will be overwhelmed, and any pause in the economic decline will be over.

Having said this, I have no clue whether the bear market rally has a week or six months left to go.

As you can see from the charts below the markets have been steadily moving higher. April's close completed the best back to back monthly performance in over six years. And, the streak continued on Friday with both the S&P 500 andNasdaq finishing higher. At this point investors appear to be more scared of missing the rally than of a market reversal.

As I've been writing, markets that climb a wall of worry are typically headed quite a bit higher and this looks to be the case now. Stocks have been able to climb in the face of one bad piece of news after another, and I look for this to be the case again this week with the release of the bank stress tests along with the unemployment numbers for the month.

We started the week with the threat of a Swine Flu pandemic followed on Wednesday with the report of a nasty 6.1 plunge in first quarter GDP....amazingly neither news was able to drive the markets lower. The S&P 500 rallied after the GDP announcement and continued higher after the FOMC statement finding silver linings in both. The Fed is desperatelytrying to keep interest rates as low as possible by buying treasuries (quantitative easing).Low interest rates traditionally boost demand, and until the consumer comes back into the economy we will ONLY have growth as long as the government continues to supply it with larger and larger amounts of fiat currency.

However, interestrates have been climbing higher as investors (China for example) demand a higher rate of return with this ENORMOUS supply of bonds hitting the market. Folks, all of these taxpayer fundedbailout plans have to be financed with government debt.... and interest rates and inflation will be THE next big issue in the coming months.

Back to the market and where we are headed. Earnings reports have been surprising to the upside.Close to 70% of companies reporting have exceeded estimates...and although estimates that have been lowered dramatically, this is still animpressive quarter. Armageddon appears to be off the table for now, and the market is responding.

In spite of continuing economic report gloom investors are grabbing onto a few bright spots--Friday morning the ISM report showed manufacturing ticking higher over last month rising to 40.1 from 36.3 in March. A reading below 50 still indicates contraction but it's heading in the right direction. Consumer confidence also rose to its highest level since last September.

Next week the earnings parade continues with 84 S&P companies reporting and we'll likely see good results relative to expectations--which should lend more support to the current uptrend. ISM services, initial jobless claims and the Unemployment Report will be released. Even with all the hand-wringing, bad employment numbers haven't been able to derail the rally--and they probably won't this time either. Bulls have been shrugging off economic news and focusing on the sectors moving higher.

The market has a great deal of momentum and it has been able to break through major resistance. Every dip in the market has been short-lived and until this changes I will look for every opportunity to go long on pullbacks. I look for oil to trade back to $35 barrel or so before this is all over, but I also expect oil to hit $200 barrel in the next 3-5 years. For those that find this hard to imagine, remember that both oil and gold are priced in US $, and that once the $ begins to crack, these commodities MUST go higher in price...just as interest rates MUST go higher and just as bond prices MUST go lower.

Until some point in the next few days to few weeks, the bear market rally will continue. We now have major support at 8000 on the Dow, and any pullback should be used to buy. At some point the "wall of worry" will be too high to climb and the decline will resume...we're just not there yet.

Make it a great week all.

Kip

Is This the Top?

Google's earnings report after the close of trading showed that while they beat the estimates pretty handily, growth is clearly showing due to a decrease in ad sales. Initially the stock traded over $20 higher to $400 + before ending at $388, up $9 on the day.

Many of the key financials closed lower, reversing earlier gains. Goldman, Wells Fargo, and Bank of America gave up all of their gains to close lower, and as you know, I believe that the stock market will only continue moving higher if the financials can keep leading the way. Personally, I think this group looks very tired, and a sharp pullback would not surprise me at all.

Earnings season continues, and all eyes will now be on GE and Citigroup, along with the scores of others reporting in the coming days. In thepast we've seen the best earningsreports announced first, which means thatwe may look back at this period and realize that Wells Fargo, JP Morgan, Google, and a handful of othersrepresented the minority of companies that actually reported above average earnings. If this is the case, then it's very, very likely that the bear market rally is going to stall (at a minimum) and that this could represent the highs we will see for some time. It's premature to make this call right now, and purely based on market internals I would expectmaybe a 3-5 day pullback followed by another rally that could still take us to 8500 or so on the Dow. This chart on the Dow issignificant. As you can clearly see, we have rallied into significant overhead resistance, and have now reached the levels last seenin early February. This overhangcould represent a large amount of selling pressure as many investors that are getting closer to breakeven from earlier purchases may want to use this opportunity to sell, thereby minimizing losses. This is why technical analysis, even ata basic level, is such an important tool.

I can just about guarantee this; if both the tech stocks and financial stocks begin to roll over and decline sharply, the overall stock market will be in very real trouble. My other concern is that Europe continues to show few signs of any recovery, and if the economic hot spots there begin to implode, this could help serve as the next catalyst that brings the bear market back with a vengeance.

Finally, much of this rally has been driven by short sellers covering their short positions. I believe that most professional short sellers covered the majority of their positions in mid-march, and are waiting patiently to begin shorting heavily once again. It actually looks like this has already started to take place, but it's impossible to tellright now. Again, trillions have been thrown into the economy by the government and FED, and it's still quite possible that theywill do whatever they can to keep this rally going. After all, they control the news cycle and they can use any tools at their disposal to try and force the market higher. It's the invisible hand at work, so we maysoon find out how much juice they really have.Remember, they have said this is an"economic war" and in war,any and all weapons can be used.

That's it for now. Make it a great Friday!

Kip

The Banks Are the Key

Meridith Whitney, another of the top ranked bank analysts, and one that has been dead right on the insolvency issues surrounding the industry over the last couple of years, came on CNBC to say that the first quarter earnings results should not be as bad as some have feared.

She went on to say that there was not a single stock in the bunch that she would own, and that the consumer debt problems (credit cards, mortgages, cars) would only get worse from here. In other words, while the bank stocks could rally a bit further from here throughe arnings reporting season, this will likely be the end of the bear market rally as it pertains to bank stocks. This makes the top 3 bank analysts very negative on the industry in the intermediate and long term. All agree that Citi will wind up being nationalized at some point, something that I have been saying since late last year.

So, here's the report card on the health of MAJOR corporate America. Our largest bank (Citi),at least two of our top auto makers (GM and Chrysler), our largest mortgage companies (Fannie and Freddie), and our largest insurance company (AIG)...are essentially owned entirely (and certainly controlled) by US taxpayers. Could you have imagined this scenario just 6-9 months ago?

And, because our government is so wonderful at running major corporations, this mess should have one heck of an interesting conclusion. Let me try and sum this ending up as succinctly as possible; when the wheels  start to fall off of this multi-trillion dollar failed bailout experiment....when reality begins to set in that nearly every single penny we have thrown at these insolvent companies was a colossal mistake...when the stock market drops to new bear market lows on huge volume...this is when we will finally see a level of anger in this country that will begin to seriously demand change for the first time throughout this entire economic meltdown. Sure, people havebeen mad to date, but we've yet to see the kinds of demonstrations and marches that are now a common occurrence throughout most of Europe. People will finally be "mad as hell and not going to take it any longer". Unfortunately, it will take the worst economy in over 70 years to snap most out of their deep slumber. In my view, only then will we see our politicians get even semi-serious about righting the wrongs that have occured over the last decade that saw criminal acts of insider dealing and a system of justice that encouraged, rather than prosecuted, these corrupt conspirators.

Finally,the charts and market internals tell me that the market is losing steam, but that it might want to make one more run before completely rolling over. Exactly when this happens is almost impossible to predict, but because this 23% bear market rally started with the banks and brokers, it will surely end with them as well. I will be watching Goldman Sachs, JP Morgan, Morgan Stanley, and Bank of America, etc., very closely for signs of capitulation. Take this final comment to the bank: bear market rallies end with a BANG, so when you see the market drop 500 points or so in one day, you will know that the next big leg down has begun.

Kip Herriage

Editor, VRA

Still Headed Higher... Thanks FASB

MARK TO MARKET ACCOUNTING CHANGES

Could the wheels be coming off of the bear market rally already? It’s certainly possible, but I think it’s more likely that either late Monday…or certainly sometime on Tuesday we will begin to see the markets head higher again. Here’s why:

MARK TO MARKET ACCOUNTING CHANGES!

The rally will be dependent on the financials ability to continue in their recovery. The BIG positive for the financials is the proposed change in the mark-to-market rules.

Banks are holding their breath that the mark-to-market rule changes proposed by FASB under Congressional mandate will be approved, and it looks like they won't have to wait long. The rule changes would suspend the mark-to-market rule for "assets in distressed markets" and widen the definition of "temporary impairments" of troubled assets. This would allow banks to write-up the value of bad assets and remove the additional capital requirements the TARP/TALF were created to solve. This could eliminate the need for the TALF in all but the worst-case situations.

This rule change, if it is approved, is expected on Thursday. The FASB issued the proposed rule changes two weeks ago after Congress grilled FASB officials and almost demanded the changes be made. There was a two-week public comment period, which ends on April 1^st, a fitting date for changing the accounting rules to allow the results of this financial crisis to simply be ignored. Not accounting for them doesn't make them go away, but it may cause some temporary bullishness in the markets.

FASB has already said the changes would be effective immediately, even prior to the full board approval on April 2nd. This pre-approval allows banks to make adjustments in their financials before they report earnings for this cycle. The vote is technically in Q2 but the pre-approval directive in March allows it to be applied to Q1 financials so earnings for the financial sector this quarter could show quite an improvement. Even though the improvement is just on paper it's liable to create quite a positive buzz as the financials typically lead the rest of the markets higher.

So…the actual economy is still on the ropes and this Friday's unemployment report is liable to prove it…in the meantime traders have been putting money to work and the financials could easily catch fire once again if the accounting rules are relaxed…and to make sure things are nice and dicey the markets are totally due for a pullback after a whopping 25% gain in just three short weeks.

Kip Herriage

Editor, VRA

This Rally Has Legs

Assuming that the market doesn’t fall apart today (down 120 points now but I think it may even close positive), today will mark the single best week we’ve had in the market since late December and for the first time in a long time I’m seeing some constructive market internals (new highs/lows, advances/declines and up volume/down volume). Maybe most importantly, the financials are looking better than they have in some time. Without a strong financial industry it is impossible for the stock market to move higher because it is impossible for the economy to recover. Goldman Sachs and Morgan Stanley led the way out, and now others are falling in line behind them. Trust me, the worst is not over in the financials, or in the market, but for the first time since last September I see some signs that the worst case scenario may be off the table…at least for now.

Of all of the government programs, the one that seems to have the most merit is the TALF plan. The Term Asset-Backed Securities Lending Facility (TALF) is officially operational as of today and is structured the way that all government programs should be. In short, the plan gets credit moving in a “public/private partnership” that only works if the private market (private investors) participates. If I was still an active investment advisor, I would absolutely want to be involved in the TALF with my clients. Very little risk and tremendous upside. So, while we still have massive credit risks in the economy, the success of the TALF would at least give us a roadmap for lessening our reliance on the secondary securitization market, which has all but dried up. Because this is where 90% of loan activity winds up, changes here were incredibly important.

So, here’s where we are. I think this rally has legs and that we could see the best bear market rally in months. Since last week we’ve seen a 15% move higher and before it’s over I wouldn’t be surprised to see the Dow at 8000…and possibly even 9000, which was the January high. This kind of move will only happen if a) short selling rules are enacted and b) changes in mark to market accounting take place. Personally, I see the changes in mark to market accounting as a band-aid but it will definitely buy the banks more time…which will extend the stock market rally.

Remember, these bear market rallies happen very quickly and then can stop on a dime. If we see the banking dominoes start to fall in Eastern Europe then this rally will end very, very quickly. This is the wild card that we should all be watching closely. I’m not predicting 9000, but the fact remains that we are due for a significant bear market rally. Industry insiders tend to act as one and there is no question that the fear of missing a big move higher is motivating the hedge fund and mutual fund industry to jump back in with both feet, being the lemmings that they are. Let’s participate with them…cautiously…and then get re-positioned for the next leg down in this bear market.

Finally, I will be at WMI’s 8th Wealth Conference from tomorrow through the 28^th so any updates will be sparse. I look forward to seeing many of you there…this will definitely be our best event ever, which is really saying something.

Kip Herriage

Editor, VRA