Market Rallies and Rhymes: Prepare Yourself Now

Mark Twain said:

“History doesn’t repeat itself, but it does rhyme.”

Right now, investors and traders are getting ready for it to rhyme again.

Earlier this week, the government felt the stock market was getting a bit too low again. Our great leaders delved into their ever-shrinking bag of tricks and pulled two of them out. In the process, they sparked the strongest rally since last summer when they stepped in.

Barney Frank, the House Financial Services Committee Chairman, told reporters he has spoke to the Securities and Exchange Commissioner and said:

“I am hopeful the uptick rule will be restored within a month.”

Frank went on to add his support to the current mark-to-market accounting rules (which will make the bank “stress tests” much less stressful).

Surprised? You shouldn’t be (we were waiting for a change in the “uptick rule”).

Analysts, pundits, and traders have been pleading for these rule changes for months. We warned the government still had these rabbits to pull out of their hats. The only question we had was “how bad would the markets have to get before they would?”

Now that the market has fallen enough, the government gives Wall Street what it wants. And Wall Street gave the government what it wants (especially right before the G20 meeting), a climbing market.

A Sucker’s Rally?

I wouldn’t get too excited yet. If this lasts through the weekend, we’ll undoubtedly be bombarded with “that was the bottom” calls. Odds are, however, this rally will sputter out very soon – just like every other government created rally in the past.

You see, bear markets are a fickle animal. The two down days, one up day pattern can and has wrecked many portfolios.

The pattern provides the right mix for complete disaster. It provides just enough hope to keep a lot of investors hanging on. In the end, there is still a lot more down than up and the markets end up lower.

Of course, this hasn’t been your average bear market. The two days down, one day up cycle has been stretched out into five down days, one up day. But those rare up days are usually pretty big ones. Whether it’s short-covering or investors thinking “that was the bottom,” hard and fast upswings are a telltale sign we’re still in a bear market.

But right now, the stock market is racing upwards. Day traders who jumped on early are enjoying a nice ride, but the ride may soon be coming to a screeching halt.

History is Rhyming

Quite frankly, I’m wary of this rally for a number of reasons. The number one reason is because it’s all coming from the anticipated swipe of a bureaucrat’s pen.

This isn’t a major change like rewriting the tax code to redistribute wealth from companies who “make too much money” (read: oil companies) and implementing policies which will increase everyone’s utility bills. That’s a different matter which forces, for better or worse, structural economic change.

This is a one-time deal like the stimulus package, an emergency Fed rate cut, or temporary ban on short selling. As we’ve seen time and time again during this downturn, they just don’t last. Just take a look in the chart below. The numbered circles are when the Government intervened (please keep in mind, I’m an analyst and publisher, not a graphic designer):

Graph 1

1. January 2008 Meltdown – Everyone thought this was the BIG ONE. The world later learned it was just the start. That wasn’t going to stop the government (or technically de facto government – Federal Reserve) from stepping in with a temporary Band-Aid. The Fed made an emergency rate cut of 0.75% – the biggest one-time cut since 1984.

2. July 2008 Bank Stocks Plummeting – “The banks were ‘fine.’” It was the short sellers to blame. SEC bans short-selling on financial stocks and sends bank shares soaring…temporarily.

3. TARP Unveiled – Nobody knew what it was supposed to do, where the money was going to go, or exactly how it was going to work, and they still don’t. But it meant most of Wall Street bets would get paid. Good enough for a brief rally.

4. Obama Stimulus – Obama won! The initial idea of $787 billion spending spree unveiled. The economy will be saved. By solar and infrastructure stocks! Or so they said. As we expected, it didn’t last.

5. Uptick Rule Reinstated and Mark-to Market Rules Relaxed – Strong three day rally which eventually ???????

See a pattern?

The government is setting them up again and, if history is any indicator, there will be a time to knock them down again soon.

There is absolutely no reason not to expect this time to be different than any other time the government intervened in the markets.

That’s why, now more than ever, you’ve got to stick to your disciplines. A couple of rule changes are not going to make too much of a difference. The U.S. and world economy are in drastic need of structural change and it’s not going to be easy.

And just wait until the fireworks really start going at the G20 meeting in a few weeks. I expect the world’s leading economies to blame the U.S. for everything, renounce President Obama’s call for them to go deeper into debt (retaliation for someone sticking their nose where it doesn’t belong), and for them to demand a stronger dollar thereby hurting U.S. exports.

Yes, I’m going out on a limb here, but it just doesn’t make any sense. But, at the Prosperity Dispatch, we also went out on a limb talking up stem cells the day after the market’s bottomed in November. And we did it again when we picked apart infrastructure stocks when they were all the rage in January.

So we’re due for being wrong on another short-term call (the markets have a way of doing that), but as long as we have sound rationale on our side and by maintaining discipline and not getting caught up in the euphoria, we’ll be better, much better off over the long run. Again, history has a way of regularly rhyming. If it rhymes this time, this rally won’t last much longer.

By Andrew Mickey

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