Guest Author - Tony Daltorio
It has been a wonderful past two weeks in the stock market. Most stock indices have posted sharp gains. Is the bear market for stocks over? Obviously no one knows for certain. The answer however is probably no.
Investors should think about how bull and bear markets operate. During bull markets, the corrections downward are short, sharp, and scary. Bear markets are similar - the corrections upward are short, sharp, and enticing.
These past two weeks have certainly seen a sharp rally and the stock market certainly looks enticing right now. This rally has been led by the group which has been beaten down the most - financial stocks. Some of these stocks have rallied hundreds of percent from their beaten down lows. Why?
The rally began last week when the federal government announced several measures to bail out financial institutions. One measure was the feds standing firmly behind the quasi-governmental mortgage agencies, Fannie Mae and Freddie Mac. These agencies always had an implicit government guarantee, now it looks like they will enjoy full government backing.
Good news? This now means that US taxpayers are on the hook for over $5 trillion in mortgages! Who knows how many of these mortgages are bad? Maybe they should now call these agencies Frannie Pay because Frannie and the rest of us taxpayers are going to be paying for this mess. Wall Street loved it because now they are off the hook!
The second measure which helped the financial stocks was the government regulatory body - the Securities and Exchange Commission (SEC)- making it difficult for speculators to short financial stocks. Shorting is the opposite of buying long - you are betting that a stock is going down. This measure forced everyone who was already short these stocks to cover, that is they were forced to buy these stocks at whatever price they could. This extensive short-covering sent financial stocks skyward. It is interesting to note that the SEC only did this for financial stocks, i.e. Wall Street, and not for any other stocks.
So much of this rally was only a government-engineered bailout of Wall Street firms. What is an investor to do? Experience tells me to 'fade' the rally. That is, go the opposite direction of the rally. If you still own financial stocks or mutual funds that are heavily exposed to financial stocks, now would be a good time to sell into the strength. And buy what has been horribly weak the past two weeks. Are you kicking yourself for missing the gains in the commodity-related stocks such as energy and agriculture, or emerging market stocks? With the huge drop in these stocks, now may be a good time to establish a position.
