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Equities rallied materially on Monday, leading many investors to wonder if this is the beginning of a new bull market or just a massive bear market rally.  Legendary investor Mark Mobius from Templeton Asset Management Ltd believes that the new bull market is already developing and "you have to be careful not to miss the opportunity."  However Martin Feldsten, a member of Obama's Financial Advisory Board and the president of the National Bureau of Economic Advisers believes that the U.S. recession will stretch into 2010.  For currencies, the sustainability of the equity market rally is critical because if stocks continue higher, it reflects an improvement in risk appetite, which would encourage investors to take their money out of U.S. dollars.

What Could Make this Rally Last?

In order for the rally in equities to last, we need to see a turnaround in the financial sector. Early indications from banks that they may turn a profit this year is a good start because it suggests that for the credit markets, the worst could be behind us.  The NY Times also reported yesterday that Goldman Sachs could return its TARP money very soon.  If this is true, it would suggest that certain banks are healthy enough to not require government capital.  Of course, Goldman's urgency is tied to the prospects of crippling taxes on executive compensation.  If there was no consequences to holding the TARP money, Goldman would have probably kept it.  Also, Goldman is in a unique situation because they received a tremendous amount of government capital as a major counterparty to AIG plus they are flush with cash.  According to the Times, Goldman has $100B in available cash so paying off a mere $10B is not a problem. Most likely, the market will not focus on these details and will instead extend its rally purely on the basis that tax payers will be getting $10B back.  At that point, investors may start to expect other banks to follow suit and if they do, it would have a positive impact on the market as a whole.  Of course, the ones that are unable to return the money could be punished.  Also, the sustainability of the rally is contingent on private investors taking the the Treasury's carrot by starting to invest in these otherwise illiquid toxic assets. However both banks and private investors appear to be initially reluctant to participate in the program which could stifle its effectiveness.

Goldman Sachs, PIMCO, Vanguard Group, BlackRock Chime in On Sustainability of Rally

 

Odds Still Favor a Return to Weakness

The odds still favor a return to weakness.  The only sectors that saw significant out performance on Monday were the financials and energy;  Investment grade corporates barely budged on the 7% rally.  The volume was also far from impressive which is always worrisome.  Two weeks ago, when we first talked about Bear Market Rallies , we said that between 1929 and 1932, during the Great Depression bear market rallies in the S&P500 ranged from 12 to 110 percent with a 25 percent rebound being the norm.  From its bottom on March 6th, the S&P500 is up 23 percent, which is right in line with a bear market rally.  We along with everyone else wants to believe that the bull market but many problems remain unresolved.  The latest plan from the Obama Administration does not address the weakness in the labor market and the prospect of 10 percent unemployment.  Also if the Public-Private Investment Program plan fails, Obama may not have enough political capital for a second chance.  A resumption of weakness in U.S. equities could mean a resumption of weakness in the U.S. dollar against the Japanese Yen and pressure on other currencies such as the Euro and British pound.  

 

Source: Bloomberg

Worth Watching: Different Perspectives on the Rally

 

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.