Tags: bear | market

Get Ready to Short This Bear Market Rally

By Hans Parisis
Friday, 08 May 2009 11:48 AM Current | Bio | Archive

I’m still convinced we are experiencing a bear market rally and, to me, the current situation is not dissimilar to the late 2001 experience.

General expectation is that there will be a temporary upturn to growth later this year due to the inventory cycle. Manufacturers have supposedly cut production so deeply that they have run off excess inventory. Hence, they will now raise production to match the prevailing lower level of sales.

This should temporarily deliver a quarter or two of growth. The question is, what happens afterwards? Well, back in 2002 activity dropped back again, triggering a 35 percent S&P slump to 770.

I am extremely skeptical about the dominant perception that U.S. inventories are lean and mean. No doubt, inventories have been slashed by U.S. manufacturers, wholesalers, and by retailers, but by far less than the pace of nominal demand contraction.

In fact, manufacturer inventories remain horrendously bloated. To be perfectly honest, I cannot see any earthly reason why manufacturers might step up production with this excess. Any demand recovery can surely be met from existing stocks.

As said before, I didn’t participate in the “rally” but have no doubt: I will short this bear market rally once the technicals tell me to do so.

I’m not in a hurry. As the economy moves closer towards outright deflation, I believe that a recovery in demand large enough to sustain any temporary upturn in production will be not be forthcoming, given manufacturing’s high inventory-to-sales ratios.

The lack of economic follow-through will, I think, see the market at new lows.

So, if you ask me “Is the bear market rally over yet?” My answer is no, but there are increasing technical indications that the advance may be approaching a point where it will pause. Indicators have reached short-term overbought extremes, which increases the odds that a pullback is approaching.

One hint toward this end may be the recent levels of the CBOE DJIA put/call ratio that dropped to 0.67 on Tuesday, May 5. That date is certainly not fatal for the market’s advance but the previous two instances of a put/call ratio at 0.64 and 0.66, on March 18 and April 13, respectively, led to a more choppy market shortly thereafter. In both cases, the DJIA was either flat or down in price, eight to 11 trading days later. After that, the rally resumed.

Also, the put/call ratio has remained below 1.00 since March 31. This more than month-long consecutive string strongly suggests that the advance is being embraced by options traders, which is consistent behavior with a push that is maturing.

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I’m still convinced we are experiencing a bear market rally and, to me, the current situation is not dissimilar to the late 2001 experience. General expectation is that there will be a temporary upturn to growth later this year due to the inventory cycle. Manufacturers have...
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2009-48-08
 

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