We are now entering the 6th bear market rally (10 - 15%) since the November lows. These are easy to handle. But a much bigger nightmare is coming your way in a few months and will send the stock market up as much as 60 - 80%. And it is your worst nightmare. How so? more after the flip.
Between 1929 and 1932 the stock market lost 90% of its value. But this did not happen right away. The process took years, and in that process, there were 5 major sucker rallies of over 20% each. The worst went from a dow bottom of 198.69 in late 1929 to the peak of 294.07 several months later, a gain of about 50%. This was devastating. And that eventual bottom at 41.22 was more than 75% BELOW that original first "bottom" of 198.69, and also about 80% below the peak of that monster sucker rally.
The effect of a 50% sucker rally (or the 60 to 80% one I predict), and of the accumulation of other "counter-trend" rallies that followis far more damaging than the original crash. Aside from the psychological terror of raising hopes only to cruelly dash them and lead people to give up, they draw perfectly good money from the safety of the sidelines to squeeze the last painful drops out of the population. Why do they happen? Human nature, probably unavoidable. People are hardwired to be optimists, otherwise there's no reason to do anything and we all drink the Jonestown Koolaid. And usually it's a good thing, as it keeps us gong through the rough times. But sometimes it can kill ya. That's what's coming later this year.
My prediction for the near term future is a month or so of range-bound dow trading in the 6650 - 6950 area. But after that a number of factors will drive the dow below 6000. These include: earnings seasons pre-announcements in which companies put their dirty laundry on the table early to cover their butts, paradoxically having the effect of leading people to believe that things are even worse than they are. ARM resets, and also an implosion of mortgage crisis hitting solid middle class people with good jobs, great credit histories, "good" debts that go bad. And then, to top it all off, there will be a wave of public sector lay-offs and collapses of pension schemes. All these will push the dow down to probably the mid 5000s where it will languish for a couple of months.....
...until, one day, quite suddenly, perhaps at the end of May, perhaps in the first couple of weeks in June, it will start to go up. For no reason at all, it will just start to go up. This will cause some wise shorts to calmly take profits, which will attract some money off the sidelines, which will make the less cautious shorts start to panic, and very soon a squeeze will be on, attracting the mo-mo players wanting a piece of the action.
Many will be cautious, fearing another secular 10 - 15% bear rally, like the six we've seen since the November lows, but when it goes to 20% and above and holds, people will be convinced and start to come back in, cautiously at first, just dipping their toes, then walking straight in, then leaping and diving. There will be a strong urge to make up losses and to make up for lost time.
People who now despair of ever being able to retire will miraculously see that opportunity appear to open up again. Investment gains will seem like a way to get enough money to get to safety in an underwater mortgage (already 20% of US homeowners are underwater and three months from now that percentage will be higher). Even more poignant will be the apparent vindication of Obama's economic policies, they will appear to have worked. Happy days will be here again, America will be back, baby. They might even start to spend.
At its peak, somewhere around 9,000 or maybe even above the psychologically important 10,000 mark, which will happen either the last week of August, the second week of Sept. or the first week of Oct. everyone will be convinced that the recession is over, we dodged a bullet, and they will be making plans, great plans, for the future.
Except that, for no reason at all, it will end, just as it started. And then, it's all down hill except for the regular secular bear market counter-trend rallies that will happen every few months, more a minor annoyance than anything else, on the way down to a dow below 4000, and the bottom of the unemployment and deflation spiral, somewhere towards the middle or end of 2010. Where it goes from there will depend on energy prices. If crude is above $200/bl and fairly scarce because of little spare production capacity. Things could stay like that for many years, or get much worse. But in any even, after the big sucker rally of 2009, 80% of folks would have lost 80% of what they had.
But, why am I telling you this and what can you do? Maybe if everybody read this and believed it, the rally could even be prevented, because people then would not give in to the irrational exuberance which will drive the astronomical short term gains, that heady mix of fear and greed and frenzy and panic which is more destructive than anything else while appearing to be the opposite. It will be like when the tsunami hit, first the tide went way way out and it looked like you could walk way out and just pick up big juicy fish flopping around in the sand, oblivious to the absence of bird or other animals, who had all retreated to the high ground, before the giant wall of water came rushing in. You have to resist the urge to go grab some big juicy free fish.
If people only went back in cautiously, there could be sustainable small gains. But that won't happen, and you know it, just like you know that Charlie Brown could not resist the drive to believe that this time it would be different and Lucy would really hold the football for him and he would really kick it. But even more to the point, Lucy herself, despite the best intentions, cannot resist the drive to pull the football away at the last second. The rich know that the middle class and poor still have some money left, and this is how they will get it from you.
So what should you do? Forewarned is forearmed. What I would do if I had any money still in equities or mutual funds or even municipal bonds and such, I would pull it out before the peak, sometime in August, calmly, at my leisure, with no sense of panic at all. But get it out and get it to safety so at least I had something to show for what I had, versus nothing. Also, it's a lot easier to walk calmly to the door when no one else has had the bright idea yet. It's all just a game of musical chairs, pick your spot long before the music stops. Later, at the bottom of the deflation spiral, that money could actually buy a bunch of assets you could use.
PS if all goes well and I am completely wrong just think how much fun you'll have telling me what an idiot I am. I would have no problem with that if that's how it works out. I would love to be wrong, but I'm probably not.