3 Reasons This Rally Is Doomed

"Markets have gone up too much, too soon, too fast."
--Nouriel Roubini

Prof. Roubini, known for having predicted the economic crisis, proclaims he's cautious in the near term because of a weak economic recovery. George Magnus, economic advisor at UBS, agrees, saying, "This recovery is entirely dependent on the unprecedented largesse of governments and central banks ... the recovery is built on very short-term foundations."

This doubt about the economy is all well and good, but one only needs to look at the recent stock market recovery to find some seriously optimistic expectations.

We must be dreaming
Since the March lows, the MSCI World Index (ACWI) has climbed by 74% and the S&P 500 has jumped 59%. Healthy companies like FedEx (NYSE: FDX  ) and Walgreen (NYSE: WAG  ) have rebounded more than 85% over the same time period, and bedridden stocks like AIG have been able to secure whopping 500% gains. Bulls are pointing to a fast, V-shaped recovery that will mirror the quickness of our slide into recession. Could a full recovery really be this immediate?

There goes the alarm
The short answer is no -- this can't be as prompt a recovery as some believe. Here are three reasons why I believe this rally is a castle made of sand.

  1. Deleveraging: Household balance sheets are fundamentally linked to property busts, which often take years to play out. People will continue to spend less and consume less as they realize the reduced worth of their assets. This is the ultimate hurdle as the economy struggles to grow, since consumer spending accounted for 70% of the economy in recent years.
  2. Government spending: Unfortunately, it seems as though our tax dollars have been behind much of the rally. Bears point to the fact that car sales slowed after the "Cash for Clunkers" program ended, and home sales will probably become sluggish when the first-time buyer tax credit extension expires next year.

    As the threat of inflation increases, and the public becomes more concerned with the ballooning of the Fed's balance sheet, government spending will slow. Magnus states that "if you don't have credit growth operating, it is hard to sustain spending while unemployment is still rising." In other words: Let's not count on the government to get us out of this mess. 
  3. Interest rates: Central banks worldwide have kept interest rates as close to zero as possible, which has increased the flow of capital into the stock market. But many people believe low interest rates (cheap money) are one of the reasons we got into this fix and think the Fed will have to raise rates sooner than later. Would investors really be throwing their money into inconsistent dividend stocks like Nordic American Tanker (NYSE: NAT  ) if they could earn 5% with CDs like they could in 2006 and 2007?

This is no time to snooze
OK, so what can you do?

You can look for growth stocks, companies like Solarfun Power Holdings (Nasdaq: SOLF  ) that operate in unproven industries but could generate great returns. But despite the market surge, Magnus argues, "the economy doesn't really go anywhere." Translation: This may not really be a great time for growth.

You can try to play it safe and look for dividend-paying stocks that have some possibility of appreciating in price. However, even steadfast, reliable stocks like JPMorgan Chase (NYSE: JPM  ) and Nokia (NYSE: NOK  ) have had to slash their dividends. It's difficult to know which dividend stocks you can count on in a turbulent market.

The smart move is to follow in the footsteps of investing gurus like Benjamin Graham, Warren Buffett, and David Dodd. In any environment, good or bad, there will always be undervalued stocks -- the tricky part is finding them. Our analysts at Motley Fool Inside Value are constantly finding great companies that are selling below their true value. These companies are operating profitably, are trading cheaply, and have responsible and reliable management. In fact, many exhibit strong growth and pay a dividend -- so we can have the best of both worlds.

Our team recently recommended Costco (Nasdaq: COST  ) , the giant retail provider with more than 550 warehouse locations across North America, Central America, and Asia. As high unemployment persists and people continue to look for cheap ways to buy goods, Costco will undoubtedly benefit. Costco has a simple, no-frills business model that has helped it maintain positive revenue and earnings growth over the past five years. It has a rock-solid balance sheet, with more than $3.7 billion in cash and only $2.3 billion in debt. And not only is this business continuing to boom, but it's trading well below its worth -- making it a great value stock.

I can't lie -- in these uncertain times, our team has picked a few stocks that haven't turned out as we would have liked. But since inception in 2004, our picks have returned more than five percentage points over the S&P 500, and we continue to work hard to bring you only the best of the best. Our analysts not only provide you with their recommendations, but they also tell you at what price to buy and at what price a stock is no longer a bargain. 

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Jordan DiPietro owns shares of General Electric. FedEx and Costco are Stock Advisor recommendations. Costco and Nokia are Motley Fool Inside Value picks. The Motley Fool owns shares of Costco. The Fool's disclosure policy is trading dirt cheap.


Read/Post Comments (31) | Recommend This Article (85)

Comments from our Foolish Readers

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  • Report this Comment On November 05, 2009, at 5:00 PM, CityWealth wrote:

    People sad they said the same thing Back in May that the rally was a "bear market rally that wouldn't last" but as it kept going on and on for over 6 months, it's quite obvious that the market doesn't care.

    How else would you explain AIG and Citigroups enromous rallies of their march lows? over %400 each, easily beating the S&P, I know because I called the rally and got in on the lows.

    Everyone has their magic 8 ball, even George soros, billionaire investor did not predict the size and scope of the bear market rally. If he couldn't do it, what makes you think a small timer like yourself can predict the end of this rally?

  • Report this Comment On November 05, 2009, at 5:58 PM, vrpirata wrote:

    CitiWealth, so your best rebuttal to the author strong points is to call him a "small timer", wow.

    Fundamentals are the key for recovery, and we don't have them. The rally may last many months more, but the longer it last without solid fundamentals, the worst it will be when coming back to reality.

  • Report this Comment On November 05, 2009, at 5:58 PM, vrpirata wrote:

    CitiWealth, so your best rebuttal to the author strong points is to call him a "small timer", wow.

    Fundamentals are the key for recovery, and we don't have them. The rally may last many months more, but the longer it last without solid fundamentals, the worst it will be when coming back to reality.

  • Report this Comment On November 05, 2009, at 6:08 PM, CityWealth wrote:

    "Fundamentals are the key for recovery, and we don't have them"

    And we didn't have them before the bear market rally, you have to understand that 60% of the markets value is the market itself (i.e. people who bought shares) as long as people keep buying the rally can keep chugging for a while, most money managers are saying the rally will end sometime in 2010, that sounds reasonable giving that everyone was calling an end to the rally Really Soon now(TM) back in May 5 months ago.

  • Report this Comment On November 05, 2009, at 6:36 PM, CityWealth wrote:

    "Rally is over" march 25, 2009, a lot of fools were saying that, they sure now in hindsight look "foolish"

    http://caps.fool.com/Blogs/ViewPost.aspx?source=isesitlnk000...

  • Report this Comment On November 05, 2009, at 7:06 PM, TMFAleph1 wrote:

    The one reason the rally will continue -- debunked:

    http://www.fool.com/investing/general/2009/11/05/the-one-rea...

  • Report this Comment On November 05, 2009, at 10:18 PM, khoonie wrote:

    History repeats itself again and again and again.

    When times are great, everyone gets over-optimistic and predicts that the rally will keep going.

    When times aren't that great, everyone gets over-pessimistic and predicts that the stock market will keep sinking. (like now for instance)

    It's simply amazing how people never learn and allow themselves to succumb to herd-think and irrational behavior economic cycle after economic cycle.

  • Report this Comment On November 05, 2009, at 10:42 PM, TMFTomGardner wrote:

    khoonie, so where do you think we are in the boom bust cycle?

  • Report this Comment On November 05, 2009, at 11:16 PM, CityWealth wrote:

    @khoonie

    Lets see your portfolio, otherwise your words are meaningless, how much did you make over the past 6 months compared toe the S&P, did you beat it or no?

  • Report this Comment On November 06, 2009, at 6:45 AM, mesapet wrote:

    This up market is a dead cat bounce. As long as you take your profits before the bear trap springs, you're fine. For the end of the bear false rise look to the price of oil and gold, which will force the Fed to raise interest rates if they get too high. Once the 30 yr bond reaches 5% or more, the DOW is going to drop like a rock.

  • Report this Comment On November 06, 2009, at 11:08 AM, noryakerson wrote:

    How much time must elapse before a bear market rally becomes a bull market? Probably about the same amount of time that a sucker's rally isn't about the suckers pouring money into it, but about the suckers on the sidelines regretting what they missed out on.

  • Report this Comment On November 06, 2009, at 11:16 AM, park94 wrote:

    Fund and Money Managers don't want to alarm anybody by running all out at the same time, which would plunge their earnings. Slow as she goes is their tactic, buying themselves time while they still can, by doing nothing just sitting there waiting.

  • Report this Comment On November 06, 2009, at 11:24 AM, xjp83x wrote:

    MyDonkey,

    Why don't you short Apple, Google, JPMorgan, Goldman Sachs while you are it? I don't believe in such stupidity with being fearful when others are greedy. Buffett didn't say that to mean that you should be fearful for every stocks that people like. Hell, that just doesn't make sense. Altria is like the most overlooked stock, hence its P/E ratio being quite low. You really have to look at the business and see if there's an imbalance with the stock price. Will the future be good for the company? Will they be the leader in their competitive business? Stuff like that. I've seen people that say sell Apple since like 5 years ago, and I can assure you that none of them were right.

  • Report this Comment On November 06, 2009, at 11:41 AM, khoonie wrote:

    @TMFTomG - my guess is we're near the bottom and heading slowly but surely out of recession, job market still sucks though.

    @CityWealth - currently about 5% over S&P, thanks in part to owning some BDK. I didn't see the crash coming but I held on tight for dear life, did not bail and took a terrifying roller coaster ride all the way down and up to where we are right now.

  • Report this Comment On November 06, 2009, at 11:55 AM, masterN17 wrote:

    Isn't it sort of irrelevant whether the rally is over or not? Just extend your time horizon and forget about market timing. Rally starts and stops decrease in significance over time. You guys wield Graham and Buffett quotes like a kid wielding a plastic sword. :p

  • Report this Comment On November 06, 2009, at 12:15 PM, cubanstockpicker wrote:

    Our "MARKET CRASH" didnt come as a one time consequence of a mistake made in 07-08. So why should this persistnet problem of complete industries being toppled be on its way up? For every construction job taken by a small business owner, or day laborer is not being replaced with another job building solar panels or what not. There is no construction, at least not enough to keep a housing boom city from becoming depopulated.

    As for the GDP numbers? An illusion looking to show growth, lol, Katrina's disaster money is being counted towards GDP. The car accident I had a month ago counted towards GDP.

  • Report this Comment On November 06, 2009, at 12:25 PM, park94 wrote:

    Well by definition they can't extend it, most are probably day traders or swing traders. They just bolster the prices carry traders are inflating and expect prices to rise infinitely. Nice to hear them so optimistic about the recovery and the govt plans though.

  • Report this Comment On November 06, 2009, at 12:40 PM, vrpirata wrote:

    CityWealth: “60% of the markets value is the market itself (i.e. people who bought shares) as long as people keep buying”

    I believe we have an agreement. You are recognizing that the market is in bubble mode again, where true value is disconnected from reality. Also confirmed by latest analysis that the market is overvalued.

    As with all bubbles, nobody can really predict when they will pop (as you correctly noted), the only correct prediction is that they will pop. Bubbles can last many months or years, they can get bigger and bigger, but they all end the same way. The market always goes back to fundamentals, it has done it every time before and there is no reason it will not do it again.

    We know that the current bubble is highly fueled by the government spending. Bank profits (assets) are being manipulated thanks to the FASB not enforcing the mark-to-market rules. Media and self interest organizations are spinning every news they get to make them sound good or not-so-bad. Walls Street celebrates every uptick even if it is due to seasonal behavior. This is like everybody wants to ignore facts and just pretend that everything is good again, like if by doing so the underlying problems would disappear.

  • Report this Comment On November 06, 2009, at 1:10 PM, elmor21 wrote:

    The "rally" length may be unpredictable, but the ultimate result of our bankrupting the country and the dollar is very predictable. The result will be disasterous but when is unknown. My best advice is to watch what our creditor nations are doing and try to invest in what they invest. Our nation seems bent on suicide like lemmings. Common sense is passe.Yes, the markets will collapse again but the timetable is unpredictable-maybe within 6 months. The average individual is worried about jobs and bases his spending on his day to day needs. Invest in what can survive under such conditions.

  • Report this Comment On November 06, 2009, at 2:22 PM, NoFearNoWay wrote:

    Exuberance is never created by smart money, when that happens smart money is in cash. Witness yet another fed made bubble.

  • Report this Comment On November 06, 2009, at 4:59 PM, DavidMets wrote:

    the dominoes will take this market down when the defecits keep mounting, congress has to have the bi-partison guts to raise taxes on those makine more than $150,000.00. The middle class is shrinking, forget the Boston tea party, we need a REVOLUTION. What did Congress do between 1796 and 1923 ?????????????????? THEY PASSED LAWS. sINCE 1923 WHEN WE STARTED THE "TAX:" to pay for war the war ?( WW1) ? THEY SPEND MONEY.!!!!!!!!!!!!!!!! wHAT IS THE RIGHT THING TO DO ? bRING BACK THE FOundation of this country !!!!!!!!!!!!!!!!!!!!!!!!!!!!!

  • Report this Comment On November 06, 2009, at 11:31 PM, jesse2159 wrote:

    Sooner or later this economy must hit the brick wall of "NO JOBS"

  • Report this Comment On November 07, 2009, at 2:03 PM, Hellier70gr wrote:

    Every rally ends at some point. Keep on predicting the end of the rally and eventually you will get it right.

    I am receiving a newletter from another financial service (not MF) and the guy was predicting the fall of the market since 2005.

    When it finally happened i had already trippled the value of my investments by not following his advice. The only good his predictions did for me was to keep me out of financial companies during these three years. If i had followed his advice as well as of those who said this is a suckers rally i would be a great looser.

    Bottom line: Unless you can time when the new downfall will come you are of little use to investors.

  • Report this Comment On November 08, 2009, at 11:56 AM, ekklesia777 wrote:

    Once again. If I had listened to the prophet of doom six months ago when he was prophlying I would have missed out on the best rally in my illustrious investing career. I say keep your finger on the trigger and ride em cowboy. Silver and Gold la la Silver and Gold. I hear old Burl Ives tuning up the pipes. Yo you remember rudulph the red nosed reindeer. Ive been singing silver and gold since June LOL Thank ya Lord

  • Report this Comment On November 08, 2009, at 12:01 PM, ekklesia777 wrote:

    Wall street doesn't like old Barack Hussein Obama I say keep on printing money like you have a press in your basement. I love it!!! Makes it real easy to know what to invest in. Long Euro short dollar long silver and gold

  • Report this Comment On November 08, 2009, at 4:52 PM, stan8331 wrote:

    Hellier70gr hit on the critical point: Bottom line: "Unless you can time when the new downfall will come you are of little use to investors."

    Unless a mega-bear provides the exact timing and percentage of decline for a predicted crash, the prediction is essentially useless as investment advice. And unless there's a long track record of accurate, specific predictions, I'm certainly not going to bet my future on someone else's certainty that doom is just around the corner.

    Anyone who is fully invested with no cash available for future buying opportunities is foolish, in this market or any other. But anyone who sits on a hoard of cash waiting for disaster is even more foolish, because even if disaster does come, timing your way in will be an extremely difficult proposition. And if your analysis is imperfect and we muddle through and disaster doesn't come, you're completely SOL.

    I prefer to follow an investment strategy that isn't entirely dependent on infallible judgment on my part...

  • Report this Comment On November 09, 2009, at 3:04 PM, ExitOnBir wrote:

    10% unemployment is not the exception anymore, it's the norm for US economy if it wants to stay competitive. 10% unemployment means 90% EMPLOYMENT, which is pretty good. If you don't get it, look at the unemployment rate of all other economies including Europe, LA and China at their good times. Welcome to the real world.

    Wealth is still there. Only held by fewer individuals, who will spend more.

    The more you wait for the end of the so called "bear market" rally, the later it is. We are almost 8 months into it, wake up. It's quite a rally.

  • Report this Comment On November 10, 2009, at 4:33 PM, fifteenfifty wrote:

    > 10% unemployment means 90% EMPLOYMENT

    Not really... actual unemployment is well beyond 10%. The official figures don't include 'discouraged' workers. And someone that lost a 100K job that now operates a mop and broom part time isn't represented as any kind of loss in these figures.

    Id say unemployment is a #1 concern for the sustainability of present market levels. Just what kind of holiday season are we going to have? Given that everyone counts on this (and the associated consumer debt) to get them through the year, I'd say things could really tank with no available credit for at least 20% of the adult population.

  • Report this Comment On November 11, 2009, at 1:43 PM, VegasMartin wrote:

    The stock market will climb as far as the dollar will fall and there are no signs that the dollar is reversing course anytime soon. Interest rates will remain near 0% for a SUBSTANTIAL amount of time according to the fed. I'm long multinational dividend paying stocks like INTC and PEP.

    http://www.ShootTheBears.com

  • Report this Comment On November 13, 2009, at 8:25 PM, jgrichard wrote:

    Only those talking yield know what they are talking about. My portfolio is 100% perferred stocks and I am up 22% from the market high in Oct. 2007. Does that beat the S&P 500?

  • Report this Comment On November 13, 2009, at 10:25 PM, GirlScoutDad wrote:

    Well, I am no expert but I am running close to the 99% percentile in CAPS, so I'll venture my two cents. In real life I am 20% cash, 5% gold, and 80% equities.

    I am very concerned about bloated federal debt and the high unemployment rate, as well as negative externalities such as geopolitical instabilities and transnational terrorism. All of this leads me to worry about a market decline as rapid as the recent advance.

    I'll put my cash back to work in equities when there's a pullback of 10 % or so.

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