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Prieur Perspective: Giving Market Benefit of the Doubt


If mid-July lows are sustained, rallies could grow.


The gyrations of financial markets ahead of the Labor Day weekend tested the patience of bulls and bears alike. As big swings took place in thinly-traded markets, I was reminded of Albert Schweitzer's words: "As we acquire more knowledge, things do not become more comprehensible but more mysterious."

None the wiser, I also did not succeed in capturing a leprechaun and finding the gold during my visit last week to the Emerald Isle. However, the beautiful Irish scenery, hospitality and "open for business" attitude resulted in a very successful trip and will keep me going back in search of "buried treasure."

Nervousness about the financial system was still paramount as investors realized that none of the problems were likely to be fixed anytime soon. The upshot of the week's trading was a further weakening in credit markets, judging by the elevated credit spreads. Global stock and bond markets ended another volatile week on a mixed note, whereas crude prices gained surprisingly little on the impending arrival of Hurricane Gustav and a festering geopolitical situation with Russia.

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I do believe we are still in a primary bear market where stock markets are, at best, faced with a prolonged convalescence period characterized by sub-optimal returns. Whether significant further declines will take place from these levels and valuations overshoot to bargain levels is anybody's guess.

However, in the short term I give the nascent stock market rallies the benefit of the doubt provided the mid-July lows are sustained. For any rally to become more enduring will require further base building and an eventual shift in central bank policy to targeting GDP growth rather than inflation.

The rally's lack of breadth, however, is worrying, causing Richard Russell (Dow Theory Letters) to warn: "If July 15 was a true bottom, the market should be roaring up today, and that's not what's been happening. Caution is warranted!"

But we should also take note of the fact that 64% of stocks in the S&P 500 are currently trading above their 50-day moving averages, as pointed out by Bespoke. "As shown in the chart below, the reading has been creeping higher and higher since mid-July, and looks to be on its way to the 80% to 85% levels seen twice over the last year. Readings above 50% are signs of a healthy market, and it hasn't been above 50% for much of 2008."

Click to enlarge

Seasonality indicates that "September has firmly secured the rank as the worst month of the year" (Stock Trader's Almanac), but that a year-end rally typically starts in late September / early October.

Let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.


"Global business sentiment remains weak and fragile and consistent with recession in the US, Europe and Japan," according to the Survey of Business Confidence of the World conducted by Moody's The survey results suggest that the Asian economy (ex. Japan) continues to post growth that is near its potential. "Across the globe, sentiment is consistent with an economy that is near recession. Pricing pressures remain very elevated, but fell notably last week."

The minutes from the FOMC meeting of August 5, released on Tuesday, indicate the committee members were concerned about the near-term risks to growth. Most participants expected inflation to fall, although they remained wary about upside risks to inflation. Given the problems in financial markets, members did not view current monetary policy as overly stimulative.

No positions in stocks mentioned.
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