As someone who likes to be optimistic, I’m finding myself in the uncomfortable position of being a bear. Bluntly put, I don’t think the current rally is going to stick.

There are 3 reasons why I’m bearish.

• The recession is getting worse. The ISM manufacturing index set a new 26-year low. Black Friday sales were not enough to prevent a steep drop in November retail sales. 553,000 jobs were lost last month – the biggest drop since December 1974.
• Valuations are not as cheap as they could be. The Dow Jones Industrial Average still trades at a double-digit P/E. There have been previous periods where the average has traded at single-digit P/Es.
• On a technical basis, the Dow had been setting lower highs and lower lows – a bearish trend. (Today’s rally could break that trend, but we would need follow-through buying to support it.)

Despite these reasons, stocks are rallying. The only plausible reason is that traders are hoping the economy will recover sooner rather than later.
 
Here is why some bulls are hopeful.

• The government is not allowing most big companies to fail. American International Group, Inc. (AIG) was thrown a lifeline; albeit at a big cost. Citigroup, Inc. (C) was given a safety net as well. The automakers might just get a bailout.
• Central banks are cutting interest rates. The ECB and the Bank of England slashed rates on Thursday. Futures are pricing in a 75 basis point cut at the Dec 16 Fed meeting.
• New stimulus is forthcoming. President-Elect Obama wants to sign a massive economic package into law as soon as he takes office. The proposal being discussed includes new infrastructure spending as well as tax cuts.
• The housing market is near a bottom, or at least perceived to be so. Mortgage rates recently dropped and there were rumors about the U.S. government proposing a program that would allow for 30-year mortgages at 4.5%.

I do believe that the combination of central bank intervention and a big stimulus package will help, if both are used effectively. The big question is timing. If one buys into the argument that the markets look 4-6 months ahead, then the current rebound suggests that a recovery could occur in late spring.
 
I think such sentiment is very optimistic. There is just too much uncertainty right now and too much margin for error.

Let’s hope my bearish sentiment proves to be overly pessimistic.

“C” Free Stock Analysis: Buy? Sell? Hold?
“AIG” Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Last 5 posts by Charles Rotblut

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