Covestor

“Don’t even hear a murmur of a prayer
It’s not dark yet, but it’s getting there.”
-Bob Dylan, “Not Dark Yet”

For the bulls, it is getting awfully dark. As recently as one month ago, every piece of data was spun positively and the market went straight up. Those days are now a distant memory. Instead, we are living with a market that refuses to rally, wastes buying power, and is set to fall lower.
The eternal optimists have decided to view the recent sell-off as a pullback in an ongoing bull market. After all, prices went so far so fast, that a consolidation was both reasonable and expected. Agreeing with the need for a consolidation, those who witness the recent action as normal are deluding themselves.

As evidence look at the past two trading days. From Tuesday’s intraday low to Wednesday’s intraday high, the Dow Jones Industrial Average (Dow) climbed an impressive 423 points. However, it was for naught. Both days finished lower as the Dow has declined 11% from its April 26 peak. Ominously, it is below the psychologically important 10,000 barrier for the first time since February 8.

Spin the story anyway you like, but this is not bullish. Instead, we have a market that is trading below its 200-day moving average and 50% retracement level. This rally is over.

Despite the overwhelming evidence, bulls will continue to grasp for reasons why this is an orderly pullback that presents an excellent buying opportunity. Four main arguments are as follows:

1.    Stocks are cheap – Forecasting robust earnings growth, we often hear that the market is trading at cheap levels. This is false. The Value Line median P/E ratio stands at 17.4. This compares with 19.7 at the July 2007 peak. While not extremely overvalued, stocks are not cheap.

2.    Excess Cash – As a result of the credit crisis, everyone has increased their liquidity position by hoarding cash. Many believe this excess cash will eventually find its way into stock buybacks, dividends, and mergers. They are wrong. For many years, both corporations and individuals viewed access to credit and cash equivalently. When banks could not renew repo lines and consumers saw their credit lines cut, the difference between cash and credit materialized. Cash levels may be high, but they represent a new norm where people seek safety over return.

3.    Economic Growth – Hiring is expanding and GDP growing. Does not this signal a boom is underway? No. Numbers are improving, but they remain so far below pre-recession levels that it will be years before lost ground has been reclaimed. The current economic bounce is welcome, but it is still very early.

4.    Oversold Bounce – Markets are oversold and many are looking for a bounce. However, oversold markets can remain that way for a long time. Just because the market went down does not mean it must now go back up.

I consider the bullish arguments weak. With the market below key support levels, the trend is lower. Eventually a rally will occur, but those occasions should be used to limit exposure and curtail risk. Until we receive a decisive rally pushing prices above the 200-day moving average, stay away from this market.