Market DNA blog August 21, 2009

1025 Breakout or Fake-out?

A 55% run up in prices since the March lows require some attention and analysis; most striking is not only the magnitude of the rally but the almost total absence of retracements and volatility. 50% plus rallies off significant bottoms are not uncommon, see Japan, US 1930s and the NASDAQ in 2000 after the first bust; however, they rarely are jumping boards for additional huge run-ups. 2003 was a clear and close exception but that recovery in the real economy, reflected by stock prices, was being artificially inflated at the cost we all are now paying. Could this occur again? That is the hope of the Fed, Government and bankers. Unfortunately this time around it is a little more tricky as they are fighting a tectonic shift in attitudes: economic agents de-leveraging will continue unabated regardless of monetary injections. That is why the monetary base (controlled by the Fed) has been increasing dramatically just to keep the money supply (eventually determined by the banking system and consumers) basically flat. In other words, economic activity will remain subdued and mostly in life support thanks to constant government action until the deleveraging cycle is complete and a new technology will spark the next boom. Unemployment will remain high for years and add to the headwinds of recovery.

In this situation it is hard to understand multiples expansion in equities. As I wrote previously, equities seem attractive below 700 (on the SP500) and even below 800 but seem rather pricey above 950. At a normalized EPS level of $60 for next year and a fair multiple of 15, we have a fair market value at 900. Expand that multiple to 20 and you have 1200 and a very speculative situation.

1200 also seems to be a potential liquidity target; this morning I twittered a few bits from MF Global and their predictions based on taking the money market funds back to trend-line (a decrease of about $400 bln) and the SP500 reaction to such an occurrence and their model predicts 1200, on liquidity only.

I can’t read much in this summer doped market action; while HFT agendas meet PPT guidelines most measures, fundamental and technical, call for dangerous waters ahead. Everyone expects the ides of September to bring the much awaited correction, just in line with the historical negativity of autumn trading; however, this pervasive certainty makes me uncomfortable, in spite of my bearish bias. Market perversion would dictate multiple failed attempts to get short in September followed by another unexpected speculative rally into November and just when everyone takes out the celebratory eggnog glasses, a bear raid will make everyone feel like the Grinch stole Xmas again.

Tight stops, risk management and size management are still your best friends out there.

Disclaimer:

The above writing is not intended as a trading or investing recommendation