Will The Stock Market Rally Continue?

The Dow and S&P pulled back this week, failing to reach the 10,000 and 1100 marks respectively; levels not seen since last October. Is this the start of a downturn, or just a lull before the next move up?

Where has the money been coming from to propel the markets, since trillions of investor dollars have been sitting on the side-lines throughout the recession in a hold pattern? A secret was kept for years, with few people aware - since the crash of 1987 the government has been supporting the markets by buying up futures contracts at opportune times to avoid steep short-term drops. The group responsible was called the “Plunge Protection Team”, and was used to avoid huge one-day collapses that have occurred historically. When Secretary Paulson announced that massive intervention would take place, he was really confirming what has been happening for the past twenty years; this time expanding the role of government intervention exponentially into areas not interfered with before at this magnitude. The government has been seeding the financial markets with stimulus money, stoking the emotions of investors - drawing on the classic greed feeling: “I don’t want to be left behind and miss out”.

What will happen when the stimulus funding stops, which will occur in the not too distant future? Also, don’t forget, there are still plenty of toxic assets sitting on the Fed’s books that have not been disposed of. This combined with a number of economic cracks in the rosy picture that analysts continue to portray, could lead to quite a different story from what is being told to us in the media today. Here are several examples of things that we have to watch out for: Sheila Bair, Chairperson of the FDIC, commented that 84 regional banks have failed this year. There is potential for another 100 to 300 banks to fail as well in the year ahead. It was reported this week that corporate staples such as Sprint Nextel - with the potential to lose 4.4 million subscribers, Macy’s - with same store sales falling and $2.4 Billion debt maturing, Goodyear - with massive debt and pension obligations, CBS - with $3.2 Billion in debt coming due in 5 years and weak advertising, and AMD - with $5 billion in debt, losing $3 billon in 2007-2008, may all face potential bankruptcies.

In the short-term, the key question, mentioned in a prior post, will be: how long will investors wait until they see real top-line revenue growth from companies before they become disenchanted with chasing stock prices? The answer is they won’t have to wait very long. We are fast approaching another earnings season that will take us into the historically volatile month of October through November. This will be a critical period where corporations will have to prove that profits are derived from revenues, not from cost cutting. If they fail to produce, there will be a strong reaction from the investor community, with cascading repercussions.

C. Cohn