The Dam is Cracking

A rally in the global equity market has gained traction over the past month, but it really a big question to ask on what it takes to hold. Globally, some US$50 trillion in net worth has vanished, but Dow wrapped up its best four-week run since 1933 last week after the economy showed signs of improvement and world leaders at the Group 20 meeting in London pledged more than US$1 trillion to ending the first global recession since World War II.

Question – are we seeing a full-fledged bull market or temporary bear market rally?

Bear in mind, sentiment can change on a dime as the market continues to experience more volatility than they have at any time in recent memory. Much of the US financial sector is still teetering on the brink of insolvency. The housing market remains in free fall and the economy is on track for its longest recession since the Great Depression.

Friday’s employment report from the Labour Department was bad again with large job losses, even government jobs. In fact, the New York Times recently reported on this disturbing trend that prior months’ data were revised down again. The department keeps concluding that its initial estimates were too optimistic. On average, from August 2008 through January 2009, the first estimate was too optimistic by 112,000 jobs. Without a February revision, the unemployment rate reached a new high of 8.5%, notching the 15th consecutive months of job losses.

Many of the real time indicators that I follow, such as corporate bond spreads, credit availability, jobless claims etc are telling me that any rally we experience in the stock market is likely to be only temporary. Consumer spending – the heart and soul of the US economy – is plunging at an unprecedented rate of nearly 9% annually – the largest decline ever recorded. In another word, there could be many false starts and this seems to be the closest definition that one could find for a bear market rally.

On the other hand, there is a mountain of cash sitting at the sidelines right now. A total of US$3.6 trillion in retail and institutional money market accounts – that is an all time record high. We don’t need to actually see good news, we just need news that is no worse than before. So, if the news flow gets ‘less bad’ the rally can be guided against its long term fundamentals and that doesn’t mean the market has reached the bottom.

This week, investors will get a glimpse of the first batch of first quarter earnings reports. Aluminum producer Alcoa Inc will be the first Dow Jones industrial to kick off the first quarter earnings session. Investors are eager to see some sector specific results as well, especially banking and retail industries.