Market Update - April 13, 2009

The current bear market rally (or new bull market, if you appear on television), continues.  For the fifth consecutive week, stocks finished higher.  As of today's close, the S&P 500 has shot up 27% in 25 trading sessions, a buying panic sparked by a string of news that is "less bad".  Last week's positive surprise came from Wells Fargo, which pre-announced much better than expected earnings on a day of light, pre-holiday trading.  With the steep yield curve, allowing banks to borrow from the Fed at 0.25% and invest in Treasuries and agencies north of 2.5%, one would think the banks could mint money.  But, at least until recently, investors expected loan losses to overwhelm these earnings.  With ongoing distress in the credit markets, it seems premature to assume the worst of the banks' problems have passed.

The rally has carried the markets to the best five-week run since 1938.  The rally has been broad, with 85% of NYSE stocks above their 50 day moving averages.  Yet the rally has been led by many of the worst performers during the bear market, including banks and homebuilders, indicating that much of the rally has been driven by short-covering.  With the bulk of first quarter earnings set to be reported over the next three weeks, the market advance has left little room for error should companies fail to deliver upside surprises.

This rally has many of the characteristics of a bear market rally: a buying panic; led by the most heavily-shorted stocks; and embraced by many market participants proclaiming that the bottom is in.  We are highly skeptical of the sustainability of the rally, but of course are happy to take advantage of it.  In previous posts, we stated that long term investors with a moderate tolerance for risk should target close to a 30% allocation to equities.  This rally is affording the opportunity for those overweight equities to reduce exposure.  For those that have missed the rally, we recommend awaiting a correction from these overbought levels prior to committing capital to equities.