Are the markets set for a pullback?


The U.S. stock market has been off to the races, since hitting a low in March.  The S&P 500 has skyrocketed a massive 34%, erasing all of the losses of 2009.  Is this a case of much too fast too soon?  And is this a bear market rally?

Before I tell you my thoughts, let me review some posts here tracing the uptick.

Back on March 5th, I asked “Is the U.S. stock market close to bottoming?” demonstrating that a number of bears like Bill Fleckenstein, Steven Leuthold, and Marc Faber had gone bullish. While I saw the potential for a short-term rally from deeply oversold levels – hence the question – I was and still am not a believer here in a sustainable secular bull market.  At the time, I said:

My own read here is this: markets tend to overshoot in both directions. This suggests that we will need to go well below fair value before this bear market is over. The price/earnings ratio on the stock market of 13 is near perceived fair value of 15 here. An overshoot could take us down to 500-600 on the S&P 500. Moreover, in 2007, corporate earnings as a percentage of GDP were at record highs, suggesting they were cyclically inflated, making those P/E ratios also inflated.

The long and short is I don’t think we are near bottom. We should see more downside before this bear market is over. However, I tend to think a bear-market rally is in the offing this year due to unprecedented stimulus. So, shorting might be as dangerous as Faber suggests, but indexing is equally dangerous. In the meantime, there are an increasing number of attractively-priced stocks out there as Faber, Fleckenstein and Leuthold can attest.

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Basically, I said no, we are not at the bottom, but a bear market rally was overdue – at some indefinite point later.  Of course, 4 days later we did hit an (intermediate) bottom – not that my quote: “I tend to think a bear-market rally is in the offing this year” says I called it (this year does not mean 4 days from now).

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In any event, this rally turned out to have a pretty good head of steam.  In the month after that, I became more bullish regarding this rally and said so in a few posts

like “Wells profit forecast is a clear bullish sign.”

Ultimately, the Wells profit announcement should make one believe that this rally is for real and, despite a potential decline due to an overbought position, can continue through to the Fall after a pullback.

To be clear, I think this is a cyclical rebound a.k.a fake recovery and it is also a massive transfer of wealth from U.S. taxpayers to banks.  But it is a rebound nonetheless and financials will benefit.

And, now there’s this whole recovery meme with a lot of data coming out better than expected.  I buy into the recovery, but the run-up in stocks has me worried.  Yesterday, I said:

Quite frankly, a 34% up move led by a weak financial sector, should give anyone pause.  I certainly called this last month.  However, the ferocity of the uptick is a bit over the top and makes me worried about downside risk.  Now that the stress tests are out and all is fine and dandy, thoughts about buying the rumour and selling the news come to mind. Let’s see where we get to over the next week.

So, where does that leave me now?  Thinking that we are overdue for a pullback.  Whether we are in the midst of a cyclical bull market is another story.  I say yes, probably.  Time will tell.

What do you think?

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