As the rally appears to be running on fumes at this point, I’d like to say that I was a little early saying to sell it before, but one never can trust a bear market rally. That’s what it still seems like we’re dealing with, too. The technicals were powerful during the 8 week surge, but we do not yet have a Dow theory buy signal (need a close above 9125) or a break above the 200 day moving average on the S&P 500. Now the charts are beginning to look more exhausted as the overbought conditions are worked out. Longer term the trend remains down as we seem to continue with the 10+ year double top formation playing out on the S&P 500.
Banks led the rally up and now they are beginning to give way as fundamentals point to a more pessimistic picture than the prior trading action of their equities might suggest. While I do feel that the substantive cash injections, ZIRP cheap liquidity and stimulus have filled part of the vacuum left by the implosion of Lehman and the deleveraging process, there is simply too much enthusiasm around when this alleged recovery is due to transpire.
We are quite literally in the midst of a complete reinvention of how the world does business and in that process there likely will be further dislocations and market abberations before settling in to a U or L-shaped recovery — either economic destiny will be determined by the shape of fiscal policy and whether insolvent institutions are infact allowed to fail or continue indefinitely as “zombies”. Unregulated derivatives markets must be brought in to the light and fully regulated in order to prevent credit default swaps and other leveraged contracts from contributing to widespread system disruptions.
This turning point has been marked by the downfall of the US as the financial capital of the world. A slow unwinding process that in the decades to come will be much more apparent than it is now. This is the unfortunate consequence of being the largest debt bearing nation in the world whose currency is quickly losing popularity as reserves for central bankers around the world. The unraveling is going to degrade the quality of life for Americans and boost domestic inflation considerably.
If nothing can be done to restore confidence by regulating the shadow markets and unraveling the insolvent institutions, then this trying period shall last quite a while. At this point I don’t feel the actions of the US government or the Federal Reserve have been constructive to that end. That is why I feel the rally is largely unsustainable and right now we are in a frothy period where short positions in equities and long positions in foreign currencies may be appropriate to consider putting back on the table.
Disclosure: Short US equities, long foreign currencies
