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What Inning is this Rally In?


Economic fundamentals are poor, yet no one knows where we're going.


Without a doubt, the strength and duration of the rally from the March low has surprised many people, me included. Inquiring minds are wondering: Is there still one-third more to come?

Barry Ritholtz makes the case that the rally may only be in 6th or 7th inning.

Noted bear Barry Ritholtz, of Fusion IQ, has been bullish on the market since March. Stocks have clawed their way back above 1,000 for the S&P 500 and the question remains: How much more to go?

"There's nothing in the technicals that we look at that tell us we're done," says Ritholtz, who authors the blog The Big Picture. "Based on history, which is no guarantee, we could be in the sixth or seventh inning of this rally..."

But there are caveats, including stubbornly cautious investor sentiment. Let's face it: A lot of us are on the sidelines (in cash), waiting for a shoe to drop.

Two Sides to the Coin

Actually, it's somewhat of a mistake to call Ritholtz a "noted bear" given that he's not perpetually bearish. He's a trader willing to play on both sides of the fence. Moreover, Ritholtz is certainly correct that there are many chart patterns that technically look good.

However, the opinion that the market can and will continue to rise is becoming ever more widespread, and ironically the bulls all say the same thing, namely "everybody else is bearish".

Mutual fund managers are not bearish, that much is certain. At 4.2%, the mutual fund cash-to-assets ratio is one of the lowest in history, in fact lower than at the 2000 top, and only a hair above the 2007 low. Those stats (from a friend) are from July. Given the continued rally, mutual fund cash on hand has probably decreased even more in August.

The Dow's dividend yield is now at the level of the the 1968 top and the September 1929 top. Good luck with that!

Even if the bearish case suffers from residual skepticism and a few underinvested hedge funds, it can't be said that the bullish case rests on any solid ground either. The rally is based on the fumes of massive money printing, not just in the US, but China, the UK, and practically everywhere else as well.

Still, as Ritholtz suggests, the S&P, Dow chart formations, and many other chart formations actually look bullish. Incidentally, the Dow looked bullish in the first half of 1930 as well, and the chart formation looks very similar.

Ritholtz also talks about "air pockets". Indeed, the market dropped so fast in 2008 that there haven't been that many key resistance levels to overcome. Once resistance is broken through, the market has blasted higher.

However, the flip side of the coin is that this market has advanced so far, so fast that if downside momentum does develop, there's nothing but air pockets below. Air pockets are thus a two-way street. If anything, there's far more air below than above.

For a clue as to fundamentals, let's take a look at bank lending.

US Credit Shrinks at Great Depression Rate

Please consider US credit shrinks at Great Depression rate prompting fears of double-dip recession.

Professor Tim Congdon, from International Monetary Research, said US bank loans have fallen at an annual pace of almost 14% in the three months to August (from $7,147 billion to $6,886 billion).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9% annual pace, the M2 money supply shrank at 12.2% and M1 shrank at 6.5%.

Mr. Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.

"The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances," he said. "It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010."

Why Did The Federal Reserve Allow This?

Please note the thought, "It's unclear why the US Federal Reserve has allowed this to occur."

The answer is easy. The Fed is not in control, it never was, and it never will be. The Fed can print money, but it can't force banks to lend.

The statement is further evidence that belief in wizards runs deep.

Please note the thought, "It's unclear why the US Federal Reserve has allowed this to occur."

The answer is easy. The Fed is not in control, it never was, and it never will be. The Fed can print money, but it can't force banks to lend.

The statement is further evidence that belief in wizards runs deep.

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