The Markets: Beware The Bear By Gareth Milliams

I was looking for an image that summed up how bad this next downturn could be. This particular bear is pretty good but maybe not ferocious enough.

We are living in strange times. Since March, the markets have been rallying and surging ever upward. Commentators on CNBC have been calling the market bottom and are heralding the beginning of a new secular bull. It isn't and it won't be for another year. Prosperity is not here and won't be until mid 2010. Don't believe the hype!

There is a gathering storm. It appears that most people cannot see that. They want to see sunshine on a rainy day. Even if we were in the most aggressive bull market, a 42% rise in Asian stocks combined with a 27% increase on the Dow in April alone would look a little extreme.

We are not in a bull market. We are in what Alan Greenspan called a "one in a hundred year event". That was back in September 2008 and he's still right.

Look closely at what propagandist Ben Bernanke said to Congress this week:

May 5 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke warned that another shock to the financial system would undercut the central bank’s forecast that the U.S. recession will give way this year to a slow recovery.

“A relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall,” Bernanke said today in testimony to the congressional Joint Economic Committee. He highlighted that the economic contraction may be slowing and that the housing market has “shown some signs of bottoming” after a three-year slump.

The Fed chief gave no indication the Fed intends to retreat from its unprecedented policy of keeping the main interest rate near zero and boosting credit through emergency-loan programs and asset purchases. His remarks echo last week’s Fed statement that, while the outlook has “improved modestly” since March, the economy may “remain weak for a time.”

Bernanke and Geithner cannot play the role of Cassandra's. They are politicians and thus have to mix the truth with optimism and cheer lead. Therefore, a statement such as “a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall,” should be read as a forecast rather than an observation.

He also stated that the housing market has "shown signs of bottoming". What signs? He provided no proof or data.According to the Wall Street Journal of May 6th 2009:

The downturn in home prices has left about 20% of U.S. homeowners owing more on a mortgage than their homes are worth, according to one new study, signaling additional challenges to the Obama administration's efforts to stabilize the housing market.

The increase in the number of such "underwater" borrowers comes amid signs that falling prices are making homes more affordable for first-time buyers and others who have been shut out of the housing market. But falling prices also make it more difficult for homeowners who get into financial trouble to refinance or sell their homes, and for others to take advantage of lower interest rates.

The Sage of Omaha himself said the following on May 2nd :

OMAHA, Neb. (MarketWatch) -- The recent drop in consumer spending and the resulting pressure on retailing, manufacturing and services industries could last "quite a long time," Berkshire Hathaway Chairman Warren Buffett said Saturday.

"I think our retail businesses will not do well for some time" as U.S. consumers save more, Buffett told investors at the company's annual shareholders meeting. "I would not look for any quick rebound in retail, manufacturing and services businesses."

The U.S. economy contracted at a 6.1% annual rate during the first quarter and unemployment soared as companies tried to adjust to a slump in global demand in the wake of the worst financial crisis since the Great Depression. Consumer spending accounted for roughly two-thirds of U.S. gross domestic product in recent years, so if that doesn't recover, the overall economy could be sluggish for some time.

Below is Art Cashin of UBS talking to CNBC.

Cashin makes a serious point. Volumes are low and getting lower, yet the market still surges ever onward. It seems that less people are convinced about the veracity of the rally and are on the sidelines counting their profits

The graph below is one that I've used before from www.dshort.com updated to reflect recent market performance. Click on it to enlarge and you'll see how this bear market rally is part of a normal pattern that we've been experiencing since Q4 2008. No market can keep falling as no market can keep rising without a correction.

All of the major recessions have followed similar patterns. The deeper the fall, the greater the bear market rally. The secret is to remember that this rally is just following a process.