This re-intermediation is not an unimportant point. Banks lend with their deposits, not with their equity. Therefore, as money flows out of negatively yielding (inflation-adjusted) money market funds into our depository institutions (in the form of CDs, passbook accounts, etc.), there should be an increased desire by the banks to lend money. As I noted earlier, all 3 of these trends have a time lag.

Consequently, over the past 6 months, I have repeatedly posed the question: “What if all of these time lags come together at once, and participants go from talking about the worst economy since the great depression to an economy that is improving better than most expected?” Not your father’s typical “V-shaped” recovery, mind you (down hard, followed by an equally sharp up recovery), and not the dreaded “L-shaped” lingering recession, but more like a “U."

Moreover, as I said in 4 Reasons Why Being Bearish Now Is a Mistake:

"The bulk of the economic stimulus monies (TALF, PPIP, etc.) is going to hit between June and September. That could make the economic numbers look much better than most expect and cause businesses to restock inventories, buy equipment, and actually hire some folks.

"This result could also compress credit spreads, which will allow corporations / individuals to roll their debt. Not just long-term debt, mind you, but lines of short-term credit, working capital debt, etc.

"Whether this turns out to be a rally in an ongoing bear market, or a new bull market, remains to be seen; but, if stocks don’t correct soon, I think you'll see another leg to the upside that will be larger than most expect, despite my cautious stance for the past month."

And that could be what the rally has been all about. Whether this turns out to be a rally in an ongoing bear market or a new bull market remains to be seen (I'm leaving that call to Dow Theory). But if stocks don’t correct soon, I think you'll see another leg to the upside that will be larger than most anticipate (I say this despite my overly cautious stance over the past month). Therefore, we continue to think it is a mistake to get too bearish. Cautious, yes. Bearish, no.

I talked to a lot of PMs in Europe over the last few weeks, and they are way under-benchmarked to stocks (especially to US stocks). They are close to being forced by their bosses to re-balance to at least a 60% stocks, 40% bonds weighting. If this happens, we could see an upside sprint into quarter’s end.

Nevertheless, while I think the recent rise in interest rates and the dollar’s dive are head fakes, there are some worrisome signs. Corporate equity issuance is one of them. Indeed, corporate equity issuance has surged to an all-time high, and insider buying is abnormally low. Meanwhile, risk appetites have risen dramatically and market breadth is deteriorating.  

I should note that the current market is not consistent with the initial legs of a new bull market we have seen in the past. First, the volume characteristics are lacking.  Second, the number of stocks rising above their respective 200-day moving averages is short of historical precedence. And third, Lowry’s Buying Power/Selling Pressure Indexes are short of all new bull market readings.

At the same time, precious metals remain on a buy signal, which is certainly positive for our investment positions, as well as my recently acquired holdings in platinum using the ETN iPath DJ-AIG Platinum (PGM). Sticking with exchange-traded funds, I recommended ING Risk Managed Natural Resource Fund (IRR) when it was selling at a substantial discount to its net asset value (or NAV). It's now selling at a 2% premium to its NAV, and I've lost my edge. Thus, the idea of banking some of the gains in IRR and moving them to the 7%-yielding Blackrock Energy and Resource Trust (BGR), which sells at a 3% discount to its NAV, makes some sense.

The Call for This Week

On May 18, in A Correction in the Cards?, I wrote:

"So far, any downside correction since the early March lows has been contained to between 5% and 6.4%. That suggests any correction of more the 6.4% could imply more of a correction than any I have seen since the demonic S&P 500 low of 666. Measuring from the May 8 closing high of 929.23, a greater-than-6.4% price decline yields a fail-safe point of slightly below 870 on the SPX. If that level is violated, it would suggest a decline to at least 830 (the 50-DMA is near 832), and maybe more."

As of yet, neither the 6.4% correction level from the highs, nor the 870 fail-safe level has been violated. Today could provide another downside test, since the mutual funds are now 90 days from the March lows, and are able to get some kind of tax break on the sale of long positions bought more than three months ago. If, however, the selling doesn’t gain much traction, we could see another rally into quarter’s end. Clearly, Friday’s upside breakout suggests that possibility. And yet, I still can’t decide whether Friday was a breakout or a fake-out that just widens the now 4-week sideways consolidation. The next few sessions should resolve the divergences.