08 May 2008

Feeding the Bear - More Arguments for the Bear Rally

Here are some excerpts from a Bloomberg piece by Michael Tsang and Nick Baker, calling the recent market surge a "suckers' rally" and questioning whether the market has priced in the turmoil from the credit crunch, housing market, recession, etc.

The biggest rally in the Standard & Poor's 500 Index in more than four years is luring investors to equities from cash, just as options traders are betting the advance will evaporate.

The benchmark index for American shares rose 4.8 percent in April, the steepest jump since December 2003, and has climbed 11 percent from a 19-month low in March. The rebound came as Federal Reserve Chairman Ben S. Bernanke arranged the bailout of Bear Stearns Cos., took subprime-tainted mortgages as collateral from investment banks and cut borrowing costs to a three-year low.

Jean-Marie Eveillard, who runs the $22 billion First Eagle Global Fund, is skeptical the gains can last because the worst housing slump since the Great Depression will reduce earnings. S&P 500 companies were valued at 22.7 times profit last week, the most in four years. Options traders are paying 63 percent more to protect against a drop in the S&P 500 than to bet on a gain, the widest difference since at least 2005.

``It may be a suckers' rally,'' said Eveillard, who is based in New York. ``Investors want to believe. But if I'm right, then there's truth to the argument that this is the worst financial crisis since the end of World War II. The same kind of reflex is the wrong reflex.''


``There are pockets in the marketplace that believe this is a sucker rally, and they're willing to pay a substantial premium for downside protection,'' said Robert Arnott, whose Pasadena, California-based Research Affiliates LLC oversees $26 billion. He said in December 2006 that a bear market was probable.

Nouriel Roubini, professor of economics and international business at New York University's Stern School of Business, says the Fed's seven rate cuts since September -- which lowered the benchmark lending rate to 2 percent from 5.25 percent -- aren't enough to stave off a contraction and that earnings expectations are unrealistic.

Investors are currently paying the highest prices relative to earnings since March 2004 and 15 percent more than when the S&P 500 reached its all-time high in October.


Gerard Minack, chief market strategist at Morgan Stanley's unit in Australia, says that's a mistake. The global economy will probably worsen, Fed rate cuts will be less effective than in previous periods and profit growth will disappoint, he wrote in a note today.

``We are in the midst of a bear market rally,'' Sydney-based Minack said.

NYU's Roubini also expects additional pain.

There is ``complacency among investors thinking that the worst is behind us for credit markets and for financial markets and for the real economy,'' the New York-based Roubini said. ``This is not the year to be in risky assets like equities.''

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