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  Posted on: Thursday, July 9, 2009
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Market Beginning Renewed Downleg

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In our view the bear market rally has ended and a renewed downleg is underway.  In our comment of March 12 we said that the market was very oversold with record negative sentiment on some indicators.  We noted that this could produce a counter-trend rally of 20-to-25% at any time.  Three days earlier on the very day of the market bottom at 666, we said the same thing on Bloomberg TV.  (Please see archives for comment with a link to youtube showing our appearance).  The rally actually exceeded our expectations with a gain of over 40% to 956, slightly over the important resistance point of 944.

The rally was based on the so-called "green shoots" thesis based on the belief that a slowdown in the rate of economic decline meant that a recovery was imminent and that the economy would soon resume its normal growth path.  From the beginning we were highly skeptical of the green shoots theory, believing that all we were witnessing was a less bad downturn rather than a return to actual growth anytime soon.  The bulls, in our view, were treating the cycle as if it were a garden-variety post-war recession, ignoring the fact that we were dealing with the aftermath of a major global credit crisis.  We felt that that the market had gone about as as far as it could go without some actual proof that the economy was really growing---a proof that would not be forthcoming anytime soon.

Now the technical picture, too, is supporting our negative fundamental outlook.  Momentum is lagging, volume is low and the S&P 500 has formed a near-classic head and shoulders top formation.  This is supported by our review of the charts that show an increasing number of stocks breaking down and fewer going up.  The bulls are betting that 2nd quarter earnings will exceed expectations and give the market a boost, but we doubt that this will happen.  Granted, we do think it likely that earnings will beat expectations since that is the way the game is played.  Knock estimates down so low that beating them is easy and then claim that earnings are fantastic.  For instance the current S&P 500 2nd quarter estimate for reported earnings is. $6.46, compared to an estimate of $9.57 on February 6th.  For those who use operating earnings, the present estimate is $14.15, compared to $20.40 0n December 10th and $16.77 on February 6th.  Beating the estimates therefore is no great feat, and is unlikely to spark the market.

In sum, we think the rally is discounting a "v"-type recovery based on flimsy evidence and a big dose of hope.  As we pointed out in our comment of June 26th, we believe that the economy will remain weak for  an extended period of time  with subdued earnings growth and sub-par P/E ratios.  The rally is topping out and a new downleg is now underway.    

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