Weekly Stocks Recap, March 13, 2009

Market Rallies From Oversold Levels!

Relief! The broad market advanced 10.7% in its best week since November. The market had gotten oversold over the past few weeks as the selling pressure and short interest intensified. It is good to see the market break the downtrend, as it had become far too easy for short sellers to make money. We like the market rebound, but are still very concerned with the downside risk, and consider the recent move more of a bear market rally. We expect the market to be rocky, swinging back and forth between a trading range of 150 points. We would like to think that last week was the beginning of a sustained bull run, but just do not think the economy and financial sector are quite ready to support a prolonged uptrend. In our view, the economy is a long way from recovery, and will likely continue to deteriorate in 2009 and perhaps into 2010. As reported last week, even if the market has hit bottom, the upside may be limited over the short term, whereas the downside risk remains high. Investors with long time horizons (5-10 years) could consider buying now, but even then we would suggest only slowly entering the market with incremental stock allocations over the next six months. In other words, if you want to resume investment in this market, invest 10% to 20% of your available cash each month into stocks. Investors do not need to hit the market bottom, to be successful over a long time horizon.

Banks Show Profitability!

What drove the market 10.7% higher in just one week? One of the big drivers was announcements from each of the three major banks (Citigroup, JP Morgan, and Bank of America) that all were profitable over the first two months of the year. That is certainly good news and the financial sector responded rising 34%! However, those increases are extreme and cannot be supported by just two months of bank profitability. Certainly the large increase is a combination of oversold levels in the financial sector and what we all hope is a break in the trend of mounting financial sector losses. Other big drivers in the market advance last week was discussion on suspension of the mark to market accounting rule and reestablishment of the uptick rule for short selling. The mark to market accounting rule has faced severe criticism during the downturn as assets were required to be severely marked down as markets for these products dried up due to the credit crisis. As asset values fell, companies were forced to report paper losses against real earnings which further eroded the valuation of these assets. A house subcommittee has taken up the issue and speculation grows that the rule will be suspended. However, no decisions have yet been made to reverse the mark to market accounting rule and the market may be getting a little ahead of itself. As for short selling, there is also movement to reestablish the uptick rule for short selling. Speculation is that the SEC may rule in favor of the uptick rule. In theory, the uptick rule requires that a stock move up in price before a short sale can be executed. The belief is that short selling has exaggerated downward market moves and the uptick rule will make it harder for short sellers to drive markets wildly down over short periods. If the rule does reduce market volatility, that would be a good thing for investors. The other positive news was that February retail sales declined less than expected and actually increased after excluding for auto sales. All in all, it was a positive week in terms of news, but in our view not substantial enough to justify the remarkable 10% swing in the market last week. We suspect much of the advance was attributable to Short sellers that had to cover positions as the market rose sharply last week.

Market Beating Foresight

Next week will bring an onslaught of economic reports on inflation, manufacturing, housing, the labor market. These measures will help us gauge the state of the economy and perhaps offer more clarity on its near term direction. The data is likely to confirm the gloomy view of the economy and its future prospects. It will interesting to see how the stock market responds particularly after the strong market gains last week. We do think the market got oversold over the past month, so part of the strong advance can be attributed to those adjustments. But as we have said before, the market remains very shaky and further downside moves are possible. We continue to believe the market will remain rocky over the next three months as job losses continue to mount and economic conditions deteriorate. The market can move up in this kind of environment as it did last week, but investors need to be prepared for large swings. In our view, the market is not yet poised for a sustained bull market advance. On a positive note, volatility (VIX) did fall significantly last week and that is one of the measures we watch closely. Lower volatility levels will help bring investors back to the market. We are currently 20%invested in our stock portfolios. We will likely sit tight on that allocation until we see more sustained optimism and strength in the market. As the market builds strength, our stock allocation will rise over time. For now, investors should remain cautious and very selective with any investments that are made.