Will the Rally Stick?

By Ian Wyatt, Daily Profit | TLT | Oct 13, 2008 | comment

*****After a full week of waiting for buyers to show some kind of strength, we finally saw it on Friday. Sure, the day started off looking like another rout as the Dow plummeted nearly 700 points to 7,882 right out of the gate.  

That plunge proved to be too much for the buyers, who took control and ramped the Dow 1,019 points before settling for a 126 point loss on the day. Thus finished the worst week in stock market history. 

Now, Friday’s 1,000 point swing was an impressive show of strength, to be sure. But I fear it’s not going to carry through to this week. 

It seems pretty clear that investors were pinning their hopes that a weekend meeting of the G20 would bring some kind of solid plan of action. At the top of the wish list was that the U.S. government follow the U.K.’s lead and guarantee inter-bank lending.

Unfortunately, no such plan came from this weekend’s emergency meetings. All we got was that Paulson’s "seriously considering" it.  

I probably don’t have to tell you that the time debating the moral hazard of a bailout is past. Investors are in no mood for vague assurances. People’s retirements are at stake. Investors want specifics, and they want them now.  

*****I expect the U.S. government will come out and guarantee loans made between banks sometime this week. After all, this is a fairly low-risk move it can make to help the credit markets and shore up investor confidence. 

And such a move could spark a very powerful market rally. For one, there’s a ridiculous amount of liquidity on the sidelines. And two, investors proved on Friday that they are willing to buy stocks. 

*****I’ve been watching a couple of bond ETFs to get a feel for investors’ risk appetite. The long bond fund is the iShares Lehman 20+ Treasury Bond Fund (NYSE:TLT). The short-term fund is the iShares Lehman Short Bond Fund (NYSE:SHV). 

It’s no secret that investors have been flocking to Treasury Bills as the one safe haven in the market. And that flight to safety drove both of these funds to record highs early last week.  

The long bond fund is off around 5% since its highs. But short bond fund is still at its highs and yielding 2.87%. And investors still prefer that 2.87% to the 5% or so average yield for a Dow Industrials stock. 

The average P/E for a Dow stock has fallen to around 12. Historically, that’s very low.  But stocks are still seen as risky because investors don’t know how long the recession will last and how far earnings will fall. If earnings estimates fall more that attractive P/E of 12 could grow to a not-so-attractive size.  

*****That’s why this earnings season is so important. I was very encouraged when IBM (NYSE:IBM) came out and reaffirmed its forward guidance in the midst of this financial meltdown. And so far, earnings have been about as expected. 

We’ll learn a lot as earnings heat up this week. Intel (Nasdaq:INTC) reports Tuesday.  JP Morgan (NYSE:JPM) is on Wednesday, Google (Nasdaq:GOOG) and Merrill Lynch (NYSE:MER) come on Thursday. 

*****Whatever happens over the next few days or weeks, I think it’s important to note a couple things. First, yeah, things are bad. Stocks just had their worst week ever. But all the talk of another Depression is ridiculous.  Business is business, and America‘s economy isn’t going down the tubes. 

We’ve weathered other storms before - the S&L crisis in the 80s, the Asian currency crisis in 1997, the Russian default in 1998, the Internet bubble and 9/11 - and come out the other side more prosperous. There should be no doubt that Americans will bounce back from this crisis, too.  

And one day, we’ll look back on this time, whether it’s today or next week or a month from now, and realize it was a great buying opportunity.

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