Reasons For a Summer Rally  

UPDATE ON THE STOCK MARKET.  Written Wednesday, July 30th, 2008:  6:30 am EST. 

Another ‘flashy-splashy’ rally yesterday  So typical of bear markets, especially those with much further in time and points to go.  Grizzly bear markets thrive on investors’ hope and adamant investor reluctance to believe things can get worse.  Bear markets end when that hope is gone.  Anyway, everyone jumped on board the stock market yesterday, figuring that, once again, the credit crunch is over or at least winding down.  I doubt that and really doubt that the nine month bear market is over but one never knows the future for sure so we always have to keep an open mind.

A SCHWARTZ RECAP.  Bulls, still fighting this bear market, did a great job of spinning (it’s always easier to spin when there is a germ of truth) that Merrill Lynch’s capital raising move yesterday and more billions in write offs showed we’re in the “end game” of this crisis.  That Merrill selling some distressed assets, doing what no one has wanted to do, selling out and thus setting a low market price, about 20 cents on the dollar, for some of their CDO’s, means that everyone else may be forced to follow suit and thus that will call an end to the prevailing uncertainty.  But this game doesn’t end with Merrill alone, this may just be the beginning of the end, which, as we all know, can go on seemingly interminably.  And subprime write downs are now just one piece of the now larger and still spreading problem, although a big part I admit.  And subprime sell offs at whatever price would have been better if done many months ago, following the old Wall Street rule which Wall Street, when pressed, totally disregarded:  “The first loss is the best loss.”  Not many are noting the awful details either, that Merrill is paying Temasek Holdings, a Singapore-owned SWF (no, not meaning Single White Female!), a sovereign wealth fund to buy more stock.  Previously Temasek bought Merrill stock and lost a bundle.  Thus in this deal Merrill is now paying Temasek a cool $2.5 billion to offset some of Temasek’s losses on that first buy.  Plus Merrill is financing the deal for Temasek and this deal will increase and dilute Merrill’s outstanding shares by 36%.  And, ironically, the sale of these CDO’s are at a price lower than Merrill’s just announced mark-to-market quarterly earnings report and stated value.  Finally, this whole new deal flies in the face of what John Thain, Merrill’s relatively new boss, has said previously, that Mother Merrill wouldn’t need or be raising any new capital.  Schwartz View:  Net, net, some say Merrill is a goner, that it will have to be taken over down the road some.  I don’t know any details but agree with the concept, that brokers will have to merge.

TECHNICAL VIEW.  IBD PUTS THE BULL BACK IN THE BOX! 

Yep, yesterday was a bullish “follow-through” day according to Investor’s Business Daily (IBD).  On the 11^th day, pretty late, after the recent July 14^th bottom, a number of key market indices followed through yesterday, that is rallied more than +1.7% and on heavier trading volume than the day before.  Obviously lower oil has been the underlying linchpin to this rally; oil down stocks up and vice versa.  Schwartz View:  My stated view is that this drop in oil will help stocks for a time, for the time it takes investors to realize that lower oil isn’t going to be the panacea for this bearish stock market.  That at some point lower oil will scare the pants off investors (so to speak) because they will see lower oil as confirmation that a recession is here and spreading globally.  But we’ll have to wait on this theory of mine as for now lower oil does means higher stock prices.

IBD goes on to remind us that:  “Every bull market in Wall street history started with a follow-through.  But not every follow-through launches a new bull market.”  I believe their stats but also know IBD has put the bull back in the box and then had to take it out a few days or a week or so later a couple times during the last few months.  So, remember, nothing, no particular indicator, is perfect, by any means. 

More Reasons For a Rally.  But I’ve also been writing that the market is oversold, that the US government has come up with a boat load of temporary fixes and props to support the stock market including the stimulus plan, unprecedented lending to non-banks and barring short selling or at least making it extremely difficult to short the financials (the SEC extended this one week ban to August 12^th yesterday).  And that a historical study of the pace of declines during extended bear markets show the market is now ahead of itself on the downside.  Plus I must say I am impressed by many European stock markets posting a sequence of five straight up days after an extended, inexorable, grinding-lower decline, i.e. a bullish Trader Vic 4-Day Rule and change of intermediate trend.  So we could certainly have a summer rally now. 

Schwartz View:  Myself I’d like to see and have written that a Dow Industrials and S&P 500 close above last Wednesday’s highs would give us a series of higher highs and higher lows, the definition of an uptrend.  Well, we didn’t get quite that high a close yesterday another good day or two could do it.  As for “Trader Vic’s” as easy as 1-2-3 change of trend, we have condition #1, a broken downtrend line and condition #2, a market which has stopped going down in place.  We don’t have, as of yet, condition #3, that’s the higher high I’m watching for.  Still, Trader Vic Sperandeo in his two excellent books from the early 1990s, get them, writes we don’t need all three, we can turn bullish with just one or two conditions met.  Just be more cautious in proceeding and realize there’s always the chance for a whipsaw and have a backup plan for what you’ll do if that happens, how fast you’ll backtrack.  With those caveats in mind, I put on some longs yesterday, not a lot and not terribly risky ones.  Basically my theme is that as crude and other commodities correct, pressure should come off the food companies, off their raw material and input and power costs.  And that at the same time these pressures diminish, food companies are successfully pushing through price increases such as mentioned by Kraft yesterday.  If this summer rally holds together, say we get a new higher high by the Dow and S&P, I’ll push the envelope for short term trading purposes further.