Chart Of The Day: Dow Breaks Through...7500?

My clients often hear me harp about inflation and the importance of looking at returns and performance on a real basis (taking out the impact of inflation). Today's Chart Of The Day comes compliments of the folks at Zero Hedge. While everyone was celebrating yesterday's close above 10,000 for the 12th time (by my rough count) in the last decade, let's not lose sight of the fact that the Dow is down 25% over the last 10 years when adjusted for the value of the dollar.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Curse Of The Contrarian

It's so ugly out there, it's hard not to be a little bullish. My contrarian sympathies have certainly been helpful in avoiding complete disasters over the years and have been instrumental in all of my most profitable investments. But everything has a cost. The curse of the contrarian is often being early in your calls, sometimes quite a bit early. That has always struck me as a very fair trade.

With the global economy now in tatters, stock markets hitting fresh multi-year lows, and journalists jockeying to see who can use the word "depression" most often in their articles, the contrarian in me is starting to feel a little frisky. Perhaps the stars are aligning for a nice rally. For today's exercise, we'll temporarily set aside all of the doom and gloom (of which I've contributed my share over the years), and we'll take a look at a few positive developments.

1. We can argue about the merits of the stimulus (and I've been against it from the start), but there's a good deal of monetary and fiscal stimulus on the way. The authorities have made it clear that they will stop at nothing to "fix" the economy. Ignoring the potential longer-term negative consequences of their prescription, the current and future stimulus (yes, there will be more) will show up in the economy.
2. Stocks in the U.S. are now off about 48% from their highs. Much bad news has been discounted.
3. Bearish sentiment has been climbing again. The herd of bulls is thinning and those remaining are far less vocal.
   
4. The Leading Economic Indicators rose for 2 straight months. Yes, it can be explained away, but at least it rose.
   
5. The money supply has been rising at a healthy clip. True, it isn't making it's way into the economy -- yet. That could change sooner than expected.
6. On a related note, there is a great deal of cash sitting on the sidelines, waiting for a little more clarity and confidence to move back into risky assets.
7. On a related note, the fixed income markets have been showing some signs of life recently.
   
8. Once again, a number of pundits are questioning Buffett's investment acumen. That's usually a good contrary signal.
   
9. New housing starts are plummeting. This will help with the excess housing inventory problem. It will still take more time, but it's happening.
10. Companies have been fairly quick to reduce costs in this downturn, and corporate balance sheets were in pretty good shape going into it. Once business finally does pick up, we could see some rapid margin expansion.
11. Based on a number of different metrics, equity valuation looks much more reasonable. We're hardly at bear market lows, but some metrics are at levels not seen in a couple of decades.
12. The market has fallen 14% since February 9th. It sure feels like we're oversold near-term.
    

That was refreshing. Again, this is not a bottom call. In the near-term, we are oversold. Markets don't go straight down. It would be more surprising to me if we didn't experience a rally imminently.

In recent days, I've added a little more market exposure, reduced our already small short position, and reduced our gold position (still one of our larger holdings). Gold is due for a healthy pullback after its recent rise, and I suspect a rally in the market may result in a decline in gold as safe haven buying temporarily wanes. Should this occur, I'll be rebuilding the gold position again.

The odds favor any rally being a trading opportunity. In the meantime, I'll enjoy basking in my relative bullishness.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

"Hall"f Baked

I have nothing against Glenn Hall of TheStreet.com personally. I know nothing about him. I'm sure he's a nice guy, but I can't believe some of what he writes. I'm starting to think that TheStreet.com doesn't have an editing staff.

Glenn writes a piece for TheStreet.com that he calls "Today's Outrage." As you can probably surmise, Glenn proceeds in each article to rant, complain, or disgrunt about his topic-du-jour. My turn. I recently read a couple of his pieces that made my jaw hit the floor.

The first one is from today's article entitled "Today's Outrage: Sears Isn't Worth $4 Billion." Glenn writes:

How can Sears be worth $31.84 a share? Target fetches only $29.54, and JC Penney is down to $16.55.

At the other end of the retail spectrum, investors are only paying $6.41 for Macy's, and at the low end, Family Dollar Stores are only trading at $26.

Wal-Mart is one of the few higher-valued competitors, with its shares at $53.

So I have to ask: Who thinks Sears is better than Target or even JC Penney for that matter?

The outrageous spread between Sears' share price and better-positioned retailers may be due for a correction after investors digest today's earnings report from Sears. The company reported a loss of $146 million for its third quarter, which ended Nov. 1, and said sales fell at both its Kmart and Sears chains in the U.S.

This is scary. We're talking Stock Investing 101. Trying to compare the value of different companies by looking at only their stock prices is beyond absurd. Price alone is irrelevant. If you're going to compare equity values of different companies you need to consider how many shares of stock are outstanding. Sears isn't "worth" $31.84 a share. Sears is worth $4 billion (market value). Sears trades at $31.84 a share because Sears has a market value of $4 billion, and the company has 126.4 million shares outstanding.

What would happen if Sears did a 2-for-1 stock split tomorrow? The share count would double to 252.8 million shares, and the price of the stock would decrease by 50% to just under $16. I suppose that this would satisfy Mr. Hall since SHLD would then have a lower stock price than Target, JC Penney, and Family Dollar Stores. Nothing fundamental would change, however. Sears would still have a market value of $4 billion, but for some reason Mr. Hall would be more satisfied with the "spread" between the various share prices. This is the kind of mistake someone completely unfamiliar with stocks might make.

For the record, the following are the market values of the companies mentioned by Glenn:

• Target: $21.7 billion
• JC Penney: $3.6 billion
• Family Dollar Stores: $3.6 billion
• Macy's: $2.7 billion
• Wal-Mart: $208 billion
  

The second piece by Hall that caught my attention is entitled "Today's Outrage: Google-O-Meter Signals Doom." Glenn writes:

The true sign of how bad it's going to get comes from Google, which is throwing its contract workers to the wolves.

The Internet search giant and ultimate barometer of consumer behavior says it will significantly reduce the number of its roughly 10,000 contractors in anticipation of a worsening economy.

No problem here. Clearly, this is yet another anecdotal sign of a weakening global economy. At the same time, good for Google. One of the knocks on the company has been its free-spending ways. If business is slowing, costs need to be cut, and reducing contract workers strikes me as a logical and reasonable place to slice. Glenn continues:

It may be the right thing to do from a fiduciary perspective, but the folks at Google don't seem to realize how damaging it is to the psyche of consumers and investors alike to see the ultimate growth machine scaling back.

He should have quit after "perspective." It's most certainly the right thing to do from a fiduciary perspective. Why in the world should Google be worried about the damage "to the psyche of consumers and investors?" This is investment analysis that only Dr. Phil and Karl Marx could like.

Is Google owned by shareholders, or is it a federal agency? Why is it up to Google to single-handedly repair investor psychology? Maybe Glenn would like Google to ramp up spending and hiring to the point at which net income will be wiped out and the stock completely destroyed (more so than it has already). I wonder what that would do to investor psyche?

I had bought some Google just before their last earnings report and sold it shortly thereafter, so I have no current position in Google. I do, however, applaud the company for getting serious about the cost side of its income statement. This will certainly help them to sustain strong free cash flow generation during the downturn. The day Google or any company starts basing its decisions on "investor and consumer psyche" is the day I short that stock.

Disclosure: The Rubbernecker is long simple math and short Dr. Phil.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

3Q08 Earnings Season and Valuation

What a week. We wrap up the worst month in the market since the 1987 crash by enjoying the best week in the market in 34 years. This neurotic bi-polar market continues to redefine everyone's view of volatility. It feels like we've had 3 years worth of action in just the past few weeks. The news flow has been incredible as well as the financial crisis continues to unfold at the same time as earnings season is in full swing.


Now that I've had a chance to catch my breath, there are a few thoughts about this earnings season that I thought I'd share as we enter the last heavy week of reporting. First of all, it isn't surprising that most of the news on the earnings front has been rather disappointing this quarter. It's looking like earnings for the quarter may end up falling 9-10%. Few firms in any industry are very upbeat about the near future although most firms claim to be very well-positioned for the long-term. This is just how things are done during a "slowdown." Mangements are typically of the optimistic sort, so when the near-term outlook is terrible, the conversation begins to focus more on the long-term, for which their enthusiasm knows no bounds. Of course, when the near-term starts to improve, we can expect the conversation to quickly shift back to their more typical, "long-term", three-month outlook.

Another point that I'd like to stress is that it gets a little more difficult during an economic downturn to assess the performance and prospects of a firm. Whatever the true reason for a slowdown in sales, a fall in margins, or a lower earnings forecast, virtually all companies will blame any shortfall on the economy. Thus, differentiating between company-specific and economy-specific reasons for a firm's poor performance gets a little tricky. No CEO really wants to say, "Hey. Not only does the economy stink, but we've been really making a mess of things around here ourselves." So, instead, blame gets shifted solely to the economy. For this reason, paying attention to a company's industry peers takes on even more importance during a recession (yes, this is a recession). If all of the companies in an industry are hurting fairly equally, it's probably the economy. The larger the differences in performance, the less likely it is that the economy is the only factor impacting the laggards.

Finally, let's take a look at earnings expectations for the fourth quarter and 2009. A report from Thomson Reuters Research came out in the middle of last week that showed that analysts were expecting earnings for the fourth quarter to increase by 32.2% and for 2009 to show growth of 15.7%. I suppose anything is possible, but these figures strike me as a touch absurd.

Let's look at earnings estimates a little closer, using Standard & Poor's data. For the fourth quarter of 2008, the estimate for S&P 500 earnings based on analyst projections (bottom-up) is calling for a 15.2% sequential increase over Q3 and a 36.8% increase year-over-year. These are operating earnings, which leave out all of the "one-time" items. Unfortunately, there isn't a comparable top-down operating number. The top-down estimates that we have come from strategists (as opposed to analysts) and are for reported earnings, which do include those "one-time" items. It's interesting to note the difference in these figures. The bottom-up (analyst) operating estimate for the fourth quarter stands at $20.82 while the top down (strategist) reported figure comes in at $12.12, 42% lower. For 2009 those numbers are $94.25 and $48.52, respectively. That's a huge difference of 48.5%. By way of comparison, the difference between the reported and operating numbers for 2007 and 2006 were 19.8% and 7.1%, respectively. The difference for 2008 is forecast to be 25% currently.

What does this mean for valuation? The S&P 500 index closed last week at 968.75. Put a 15 multiple (arbitrary) on the $94.25 figure for 2009, and you get a level for the S&P 500 of 1413, implying that the market is undervalued by 45% currently. Put that 15 P/E on the $48.52 figure, however, and we find fair value at 727, implying the market is overvalued still by 25%.

There are two points to this analysis. First of all, the bottom-up estimates from the analysts are almost always too optimistic, particularly during a downturn. The analysts are being spoon-fed by optimistic managements and are therefore very slow to bring their numbers down to better reflect reality.

The other point is that we have to be very careful when trying to value the market using P/E analysis. There are a number of different earnings measures and time frames that can be used. The use of a particular P/E multiple is also highly subjective. Care must be taken not to mix a forward (2009) earnings estimate with a P/E based on historical trailing earnings. Forward P/Es must be applied to forward earnings, and trailing P/Es must be applied to trailing earnings. Better yet, these inputs should be normalized for the business cycle. Unfortunately, rather than approach valuation objectively, many people tend to use the combination of earnings and multiple that best helps them justify the bullish or bearish view they already hold. This is called data mining, and it's a dangerous substitute for objective analysis.

Disclosure: The Rubbernecker is long mining, but not data mining.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Nearly A 1000-Point Rally. Whaddya Know!?

When I wrote in last Friday's post that "Just a decrease in the amount or severity of the bad news (second derivative) could propel a near-term 1000-point Dow rally (not necessarily all in one day)," I have to admit that I wasn't expecting it would all come the very next trading day. Although I like to think that my expertise lies in long-term investing, my shorter-term calls of late haven't been too shabby. Our SSO and QLD positions are up 36% on average after 1 1/2 trading days. Since patting oneself on the back in this business is a sure kiss of death, I'll leave the self-congratulations at that and move on. Luck, intelligence or intelligent luck, we'll take it.

As I also wrote in the Friday post, "If we do get the rally, I won't be shy about closing out these positions as this is not some grand market bottom call. In fact, the more powerful the rally, the more likely I'll be to rebuild the short side of the portfolio." With today's 11.5% rally in the S&P 500, let's just say that I'm now 100 S&P points less bullish than I was just yesterday. The earnings outlook hasn't changed in my view since last night, so valuation, which was finally getting interesting, is now 11.5% less compelling than last night.

With that in mind, I'm certainly impressed that the market rallied strongly into the close and closed right near its high. Investors have regained their confidence (at least for the moment) that the entire global monetary system isn't about to implode. Just as they rushed out of the market in fear as it was collapsing, they are now rushing back in -- this time in fear of missing the rebound.

Whether we've seen the lows of this cycle remains to be seen. Let's not forget that just as bull markets are marked by retrenchments, bear markets are marked by the occasional rally. These rallies are called "sucker rallies" for a reason, and they can be powerful. Following the October crash of 1929, the stock market experienced a nearly 50% rally over a 5 month period before continuing its crushing descent.

Will this rally be short-lived, or will it continue into year-end? There's no way of knowing, but I have no intention of overstaying my welcome. I suspect this move may well have more legs to it, but I also suspect that our recent QQQ and S&P positions will have a fairly short shelf-life in our portfolios. At a minimum, we'll begin scaling out of them very soon should the markets move higher still. Should the rally continue significantly higher, I fully anticipate once again ratcheting up some short positions.

One area that I'm very upbeat on that was left behind by today's rally is gold-related equities. The global flight-out-of-safety that we saw today left gold with a nearly $18 loss on the day. Governments around the globe are publicly announcing that they will print whatever amount of money is necessary to prevent the global financial system from imploding, yet gold is nearly 17% off its high, and gold mining stocks (particularly the junior miners) have been a complete disaster of late.

Events in recent weeks have served to remind the world of gold's value. Mints around the world are unable to keep up with demand for gold coins, and central banks are likely to cherish what gold they have left. On the supply side, exploration is becoming tougher and more expensive, and production is far from robust.

Gold prices and stocks are sure to be volatile, but both look very attractive at the moment, and I'll very likely be putting recent gains and some cash to work in this area imminently. My preference is to have exposure directly to the price of gold as well as to gold mining stocks, but new money will most likely be going into the mining equities given their recent drubbing. I believe that many of these stocks (particularly the juniors) will be triple-digit percentage winners from these levels.

Disclosure: The Rubbernecker is long gift horses and short all of the bottom-calling pundits.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Is the Coast Clear - Again?

Over the past month, we've seen the S&P 500 (first chart) rebound by about 11%, and we've seen the volatility index (second chart - measures expected market volatility over the next 30 days) decline markedly from last month's high. It's no surprise that over this same period the "experts" have once again been coming out of the woodwork to proclaim that the worst is behind us and that this is a great buying opportunity. Of course, many of these gurus never noticed this huge credit bubble building or foresaw its demise. Regardless, CNBC doesn't hesitate to reserve plenty of air time for their endless droning.

For the sake of fairness, there's always a chance that we have seen the worst, and there's a chance that the stock market could rally to new highs and beyond this year. There's also a chance that professional lawn bowling will take our country by storm or that a global tone deafness virus will sufficiently affect the population to allow me to become the next American Idol.

In my humble and increasingly out-of-favor view, what we are witnessing is standard bear market activity. As discussed in an earlier post, just as bull markets are marked by the occasional 10%+ retrenchment, bear markets experience the occasional 10%+ rally. Sentiment swings violently and on a dime. One minute, everyone is fearing Armageddon and the next everyone is shoving Granny out of the way to get in "at the bottom".

Why my continued pessimism? Here is a brief summary of a few concerns:

• Economic growth in recent years was fueled largely by an ever-increasing amount of debt rather than through savings. This was never sustainable long-term and is finally reversing.
• Consumers became increasingly reliant on extracting equity from their homes this decade in order to fund their lifestyle. With home prices off sharply and mortgage availability far more limited, this source of "income" is largely gone.
• Higher oil prices are likely here to stay. Though they could dip somewhat in the face of a global economic slowdown, the longer-term trend is likely to be higher as high depletion rates and limited significant exploration success fail to keep up with growing demand.
• Roughly 70% of GDP comes from consumer spending. The consumer is stretched to the max as evidenced by soaring foreclosure rates and credit card defaults. In addition, wage growth has been anemic. It's time for the consumer to start saving and rebuild his/her balance sheet.
• The housing market is likely to be weak for much longer than most expect. Sales are plummeting and inventory continues to grow. In the hot markets that experienced the most overheating, asking prices still bear no relation to rents - as they should. Ultimately, prices will need to fall to levels that make houses more affordable for homeowners or to levels at which investors can rent them out for a positive cash flow.
  
• We haven't even begun to see the impact of Option ARM defaults. These will be rolling to higher interest rates in the next couple of years, and it's likely that the loss experience of these homeowners won't be terribly different than that of the subprime lot.
  
• State and local budgets are going to become a big issue. With tax receipts falling and expenditures remaining high, many states will be faced with some hard choices given their balanced budget mandates. Taxes will need to be raised and/or spending cut.
• Banks remain very hesitant to lend. Liquidity is king. There is plenty of corporate debt coming due in the next couple of years, and it will be crucial for companies to roll this debt over at reasonable rates. Otherwise, interest expense will increase and/or shareholders will experience dilution as more companies are forced to sell stock to redeem their debt.
• The losses banks have taken thus far have been largely mark-to-market accounting related losses. Once the slowing economy begins to impact the general economy, we will see increasing corporate defaults.
• More and more companies are lowering their capital expenditure plans and announcing layoffs. Clearly, the financial industry is currently experiencing a net outflow of jobs. This will likely start to trickle through much of the rest of the economy this year.
  
• Inflation continues to surge, regardless of what the corrupt government statistics indicate. We all know what we're paying for gas, food, utilities, education, health care, etc.
  
• With the dollar weakening and inflation rising, it wouldn't be surprising if our lenders (China, Japan) soon started demanding a higher interest rate on their government security purchases. This would help the dollar but wreak havoc on an already weak economy.
  

Even with all of these issues, stocks could be a buy for those with a longer-term outlook if valuation were attractive enough. If I believed that stock prices more than adequately discounted all of the above concerns, I would be bullish. Unfortunately, that just isn't the case. As with most investments, you make your money when you buy. History has clearly shown that the initial valuation of stocks is a terrific guide to future returns. The lower the initial valuation the better the future returns - in general. Currently, we're still at the high end of the historical range of valuation. The P/E for 2009 is up in the mid-teens. Given all of the problems cited above, this hardly strikes me as a compelling entry point for the market as a whole. History has shown that future returns tend to be anemic when starting from these levels (just look at the last 10 years).

I do believe that, although the bulls are back in control for the moment, we will look back at this rally and see that it was another dead-cat bounce (bear market rally). Near-term, I intend to add to select short positions. The stock market has held up well so far during this earnings season, but this is more a function of expectations having been set unreasonably low going into the earnings reports. When you expect Armageddon but end up with purgatory that looks like good news. I expect a fairly ugly pre-announcement season for next quarter and will increase my shorts leading into it should the market continue to move higher and sentiment remain bullish.

Google - A Contrarian View

We saw quite a love-fest for Google on Friday following their Q1 earnings release. Given how important this report was for the market and for psychology, it's worth spending a little time on it.

Earlier in the week, comScore released a report in which they estimated Google's paid clicks grew only 2% during the first quarter. Concerns about this slowing had led to a sharp decline in the stock price of Google since the beginning of the year, falling from just over $700 to about $412 last month. With Thursday's earnings release, Google disclosed that its paid click growth actually increased 20% in the quarter. With revenue and earnings coming in above the whisper numbers (GOOG doesn't provide earnings guidance), we saw a huge relief spike in the stock.

There is plenty of positive press out there, so there's really no point in just rehashing it. Let's have a little fun instead and play devil's advocate.

• Even though paid click growth came in well above expectations, the 20% increase is a marked deceleration from last year's 43% growth rate. The bulls and the company argue that this is due to an intentional move by the company to decrease the quantity and improve the quality of presented ads. They hope to charge more for the fewer higher quality ads to offset the volume decrease. When asked about this on the call, management essentially said that the improvements were made later in the quarter, and it was too early to judge their impact. Fair enough on pricing, but then why the decline in paid click growth to 20%?
  

• ComScore claims that they only monitor US consumer growth, but Google's paid click data includes international. It seems very likely that US growth has matured and slowed dramatically while international growth remains very strong. If so, the fact that the huge US market has slowed so dramatically and so soon should be very concerning.
  

• Year-over-year revenue growth has been steadily declining.

• The company was adamant that they have seen no impact from the slowing of the economy. I don't really get this. Overall growth at GOOG is clearly slowing, and it appears that U.S. growth is slowing dramatically. How the company can be sure that the economy isn't a factor isn't at all clear. It seems logical to think that the economy has played some role and that growth may have been even stronger had the economy not weakened. Investors are typically less likely to pay a premium multiple for an economically-sensitive growth stock.
  

• GOOG is trading at 26x this year's EPS estimate. That's not particularly cheap, especially given the slowing growth trends (EPS growth is much lumpier, but it too has been slowing).

• Let's not forget the law of large numbers. Growing $5 billion of revenue at a 40% rate is much harder than growing $100 million at the same pace. Let's make sure expectations are realistic. Were Google to increase revenue at a 40% annual clip, they would overtake the current GDP of the U.S. in just under 19 years. That's not going to happen. As can be seen from the price action of GOOG stock this year, the market doesn't take kindly to strong growth stocks that falter. It's just a matter of time given their revenue base.
  

• As for this quarter, the company did benefit from a tax rate that was 1% lower than last quarter due to international growth (and weaker US?). That boosted EPS by about 7 cents. Also, though it wasn't discussed, clearly the company was a big beneficiary of the weaker dollar in the quarter. That's fine, but it isn't growth driven by improving operations. So, the quality of the earnings beat wasn't quite as dramatic as the press would have you believe.
  

Bottom line: We saw a huge relief rally when the paid click number came in much better than feared and the company exceeded revenue and earnings expectations. This was a case of the bar being set pretty low and being relatively easy to hurdle. The market had priced in worse numbers than the company posted, so the stock rallied. However, the quality of the beat was not as solid as indicated in the press, and the longer-term trend of slowing growth continues.

I'll be keeping an eye on GOOG and possibly adding a long put position as we move through the quarter should the stock continue climbing and volatility moderate.

UBS and The Market Rally

We’re off to an interesting start to the second quarter. Swiss banking giant UBS reported that it will be taking a $19 billion write-down and about a $12 billion net loss for the first quarter. This is on top of last quarter’s roughly $12.5 billion loss. $24 billionish gone in two quarters. So how far down is the stock right now? Well, it’s actually up 14%. Sounds like a bad April Fool’s joke. Too bad they didn’t write-off $40 billion – their stock might be up 30%!

So what’s going on here? First off, they’ve announced the resignation of their Chairman. You lose $20+ billion in 6 months you should probably lose your job. More importantly, the company claims to have substantially reduced its exposure to real-estate-related assets (subprime exposure fell to $15 billion from $27.6 billion last quarter) and will create a new wholly-owned unit to hold its remaining illiquid real-estate assets. UBS also said that it will be raising $15 billion of new capital, after having just raised $13 billion in February.

What does this all mean, and why is this stock and the market moving higher? Clearly, the market wants to believe that the company (as well as the financial industry) has put the worst of the credit crisis behind it and that there will be minimal future write-offs and plenty of additional capital raised. The fact that UBS is able to raise another $15 billion is also seen as a bullish sign since this would have proven difficult (at least on reasonable terms) if their balance sheet was too ugly. Finally, the bank’s Tier 1 capital will remain at a fairly healthy level for the time being following the capital raise.

As for moving the remaining exposure to a separate wholly-owned firm, UBS may be doing this to enable it to sell the entire lot at one time to a single buyer versus piece-meal in the open market. It seems that whether that happens or not, this move will allow UBS to "focus" investors on its “core” business since these poorly-performing assets will be segregated.

With the additional news that Lehman is also raising capital and that Morgan Stanley has further reduced its exposure to bad assets, it seems investors are eager to sound the all-clear and jump back into financials and equities in general. Is the worst really behind us? Was that it? From peak to trough the S&P 500 fell about 20% in 6 months - quite a bit less than the two-year 50%ish drop following the bursting of the tech bubble and relatively mild as far as bear markets go.

This credit bubble is the biggest bubble we’ve ever seen in dollar terms and in terms of breadth. Far more people are affected by falling home prices and rising mortgage payments than falling stock prices (although the combination is pretty lethal), and far more people are more dangerously over-extended when it comes to credit now than we’ve ever seen. Little of the damage we’ve seen so far has come from the obvious slowing of the economy. We still have that to look forward to.

Furthermore, although equity valuation isn’t as rich as it was at the start of the last bear market, the current P/E on the 2008 S&P 500 estimated reported earnings is still about 20x. Future returns are rarely exciting when starting from such an elevated level. It's also very likely that earnings estimates for the balance of the year are still over-stated and need to come down, particularly given the difficulties in the financial and consumer sectors. Weak personal income growth, rising foreclosures, a struggling financial industry, higher inflation, a lack of ready access to cheap capital, rising/high commodity input prices, and high equity valuation is hardly the recipe for a new and powerful bull market.

Given all of these issues, the odds that the crisis is over appears to remain low. Even if we’ve seen the lows in the market (which I doubt), it’s hard to imagine that we’re off to the races again. Bear markets are marked by intermediate and short-term rallies. These are called dead-cat bounces and sucker rallies. Look back to the 2000-2002 period. You see a number of 10-20% rallies during that bear market. I strongly suspect that what we’re seeing lately is another dead-cat bounce, just like we saw this past November and January. As the market becomes short-term oversold on strong negative sentiment almost any news short of Armageddon gets interpreted positively. That’s in part why a $19 billion write-down can result in an 14% rise in your stock.

We’ve been due for a nice rally. Markets don’t move in just one direction. Sentiment was so bad it had to improve - at least temporarily. I wouldn’t be surprised to see this rally continue a bit, but it should face a stiff headwind as companies start reporting first quarter earnings in a couple of weeks. I expect to see fairly cautious guidance from companies on the balance of the year and earnings estimates being reined in. I would be very hesitant to chase the market during this rally. However, the long-term thesis for commodities/precious metals is still attractive, and the recent pullback in this sector is healthy and is likely providing a nice opportunity to nibble.