Tuesday, October 20, 2009

Hussman: The Stock Market Has Never Been This (Intermediate-Term) Overbought

I have talked a lot about the market uptrend being a "dead cat bounce".

What's a dead cat bounce?

It's a period after a severe downturn where the market turns up temporarily before resuming a downtrend. The upturn is caused by the fact that in the prior panic period, the desire to hold cash becomes extreme. Market traders who hold strong cash positions start buying into the market, but, unless the Fed is printing money (which they are not now) the traders eventually simply run out of fuel (cash).

The current period is complicated by the fact that the Fed did pump enormous sums of money between September 2008 and February 2009 (15% annualized M2 nsa growth), so that is working its way through the system. Since that money printing has stopped, at some point a severe crash seems ahead.

John P. Hussman Ph D of Hussman Funds this great comment on the nature "dead cat bounce" periods, although he does not refer to them as such:
One of the notable features of extreme overbought conditions is that investors rarely have much opportunity to get out, just like the fast and furious advances that clear oversold conditions tend to occur too quickly to capture unless one has already established a position. As for the present, we have rarely seen 90% of stocks suspended above their 50- and 200-day moving averages for as sustained a period as we have now observed.
His warning about the banking sector is also worthy of note:
My impression of the U.S. banking system is that it is quietly going insolvent, in a manner that will become evident only when the slack for “significant judgment” (provided by the FASB earlier this year when it altered mark-to-market rules) is taken up so tightly that the rope snaps. Presently, this slack has allowed banks some time, but the question is, time for what? The rules encourage banks to neither modify loans nor foreclose, both which would trigger a restatement of value on the mortgage asset. Meanwhile, banks are reluctant to allow “short sales” in lieu of foreclosure (where a homeowner sells a home to avoid foreclosure, but at a price less than the residual loan value, so the bank has to essentially eat the loss). This again defers the restatement of asset values for a while, but makes business sense only if home prices are expected to recover faster than the foregone interest that could be earned on new loans.

So if you talk to people who oversee these assets, including people who work with the FDIC, you'll hear that there is an inventory of unrecognized losses being built up, in hopes that the underlying mortgages will turn around without the need for loss reporting. In view of the CRL foreclosure projections, all we can think is – fat chance
This is not the time to be a lackadaisical speculator. There are more land mines and road side bombs here than in Iraq and Afghanistan combined.

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