The Bottom is For Real, But A Pause is Due

The stock market has rallied sharply since the middle of March leaving a lot of bears wandering and wondering in the woods.

The chart at the right shows that the Dow has rallied close to 2000 points, or nearly 30%, since the bottom on March 9. The chart also shows that the Dow has now reached the 200 day moving average (blue line). We think the market may pause here. One reason for this belief is the long sideways trading action from July 2008 through the middle of October 2008. This trading range left a lot of traders with significant losses as stocks collapsed in February. Human nature says those traders will become sellers as the market moves closer to Dow 9,000.

We believe this pause in the market's recent upward march will be temporary. Stocks will continue higher later in the summer as Wall Street earnings estimates begin to turn higher in recognition of an improving economy.

As you may remember, we said on March 20, that we believed forces were in place to produce a turn in stocks. We have reiterated that call three additional times since then. The bottom line on these calls was and is the undergirding and strengthening of the banks.

We believe the collapse in the market in February was caused by Treasury Secretary Timothy Geithner's February 10th speech that was supposed to answer all of our questions about how the government was going to rescue the banks. Mr. Geithner did not distinguish himself in that speech and questions began to fly about the possibility of "nationalizing" the banks. Bank nationalization fears were unleashed when Mr. Geithner announced that the banks would be subjected to rigorous stress tests.

Nationalization of the banks combined with the realization that the US auto industry was bankrupt caused investors to "think the worst" and abandon stocks. Stocks finally found a bottom as the Administration repeatedly promised that they had no intentions of nationalizing the banks. Indeed, the Administration continued to champion the idea that the banks were in reasonably good shape but needed more capital, which they were willing to provide.

By late April the results of the stress tests were announced and showed that only about half of the banks tested needed additional capital and none of them appeared to be close to a government takeover.

Stocks gained upward momentum as those banks who were cited as needing more capital were able to sell additional stock in the open market. This would have been impossible before the results of the stress tests.

Adding power to the run-up in stocks has been a string of economic news that can best be described as "less bad" than before. Few data show truly good numbers, but it is clear that the economy is starting to respond to the Fed's very low interest rates and numerous programs to aid homeowners.

The news will not show positive data for many months yet, but we believe the worst is behind us.