Beginning of a Bull or Breather for the Bear?

S&P 500 hit 12-year low on March 9 – since then the index gained close 25% - the best rally since 1933. Question – is this the beginning of a bull market or just a breather for the bear?

One thing, we should be very clear that the 1933 rally came after a record-breaking decline. Real GDP fell 25% during the Great Depression and Dow fell by almost 90%. In 1949, the Dow was selling at P/E of just 7 times. And this time around, the S&P 500 fell 58% from its 2007 peak to its March 9 bottom.

So, the happy days are not here again, at least not yet.

In this market, the Dow was above 7,000 – within 50% of its 14,164 peak – continually from May 1997 until February 2009 and the current rally has been based on signs that the US banking system is not about to expire – a development that worry me hell a lot. With short-term rates well below long term rates, banks’ on-going lending business is currently exceptionally profitable and the economy may actually be beginning a lengthy ‘bottoming-out’ process.

With imbalances in size of expansive monetary policy and record peacetime deficits – deficits that are more than double the previous peacetime record, there can no assurance that a recessionary bottom will be followed by recovery, quite the opposite, I think.

The high stock prices of 1996-2008 have gone. Take the 1949 P/E multiple of 7, and apply it to a recovering earnings level of say $60 on the S&P 500, and you get an S&P of 420 – an equivalent to a Dow of around 4,500 level. We can expect an eventual low well below the 6,547 the Dow reached last month, and any rally to be temporary.

Don’t get sugarcoated and the unmistakable reality is that, despite any government guarantees, there is no question that downside risk remains. The perplexing divergence between growing investor optimism and the fundamentally abysmal economic situation will continue to build and this tells me a top of this wave of risky assets is near, if not already here, and a sharp reversal will follow.