Rally: Too Flashy For Our Liking

David Rosenberg, the soon-to-be former Economist for Merrill Lynch, had a very prescient commentary last week about the 25% four week rally on Friday:

As for this 25% rally in three weeks – the consensus has swung to the view that this is a real inflection point. One warning. We saw this happen in late 2001 and early 2002 too … big, big rally; early cyclicals flew; the markets thought we were in for a V-shaped recovery … it was longer away than many at the time believed and many were burnt as a result. And keep in mind that the ‘second derivative’ on growth began to improve in the fourth quarter of 2001, and the S&P 500 still did not bottom for another year.

Currently, the equity market is priced for $70 on earnings on a going-forward basis, or a 75% rebound. And with retailing stocks up 30%, leisure/accommodation up 35%, and the homebuilders up 40%, the market is priced, amazingly, for a revival that is led by the consumer! (in fact, the only S&P sector that is now trading at P/E multiples that are at post-2001 highs is the consumer cyclical group). If we see that in the next year, we will be the first to hang up our Hewlett Packards. Being up 25% in a year and staying bearish … well, shame.

Achieving that in less than a month – come on. Too flashy for our liking.

In fact, let’s learn from history. The only times we have ever seen the stock market surge close to this much in such a short time frame were:

* December 1929
* June 1931
* August 1932
* May 1933
* July 1938
* September 1982

Only in September 1982 and in May 1933 was the equity market embarking on a new bull phase. But guess what? By the time the S&P 500 surged 25%, it had already crossed above its 200-day moving average. So call us when the S&P 500 crosses the 1,000 mark – another 20% to go. That is how deeply entrenched this particular bear market has been – that even after this massive rally, the onus is still on the bulls! Consider as well that on 4 of the 6 occasions that the equity market staged such a huge rally over such a short time period, it relapsed. So we are going to wait this out, acknowledging that we could be late to the party. We still feel the downside risks are too high to be involved.

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