What's up with the current rally: sometimes just believing is enough.
The market continues to defy….and that’s what will keep it doing well, because nobody thinks it will. I have never seen a more anticipated correction than the one we should, but are not getting. Most people have been left on the sidelines scratching their heads. The new mantra I hear now is “I’m waiting for the pullback and then I’ll get in!” that alone tells us it will likely leave people in the dust. Once they capitulate and finally “get in”, the market will then be ripe for this so overdue correction. That may be quite a bit higher.

The big surprise was the .5% in personal income for April. This is showing that the stimulus money is finally working its way into the economy. The leading economic indicators are pointing towards a recovery, and that’s why the market is rising. Add in the improving sentiment, which was so negative it swung violently the other way, depleted inventories and a consumer’s penchant to spend even though they can’t afford it, and you’ve got a recipe for a higher market. Not to mention that people are naturally optimistic creatures and they are all are sick and tired of being sick and tired. They want to have a reason to be positive. Now they have one, for now.

The current strong V-shaped rally is more characteristic of bear market rallies. Traders suddenly have become nearly as bullish as they were at the top of the market in October 2007. This trend shows too much “hope” given the massive blows that the U.S. financial systems have taken. There are also many short positions from traders that doubted the rally that continue to unwind and add fuel to the bullish trends. Broad, new bull markets tend to rise in stair-step patterns with clear consolidations between each step. For example, the last bull market rally began in early October 2002 and continued strongly into January 2003. However, a near-retest of the lows occurred into March 2003. After that, the market rallied strongly into January 2004 with an 8-month consolidation into October 2004, and so on.

Long term: The obstacles have not disappeared and will only make the fall that much harder when the realization hits that we are simply not going to get back to the same pre-crash economic. The subprime crisis was only the first debt crisis of many to come, which will include prime, commercial real estate, credit card, and commercial/business loan failures. We have begun a deleveraging process that is overwhelming, given that U.S. total debt is now over $52 trillion (371% of GDP as of 12/31/08 or now 381% as of 4/30/09).

Real Estate: The subprime crisis was the first to hit the banks hard. Now, prime loan defaults are approaching those of subprime loans. Commercial real estate failures, credit card defaults, and business bankruptcies all will increase over time as unemployment rises, which will be higher than the government wants to admit, closer to 12-15%. Ultimately, defaults on prime loans will be much higher than defaults on subprime loans have been, because many people bought homes at greatly inflated rates between 2003 and 2007. More homes will be worth less than the mortgages on them and more households will either demand that the mortgages be restructured or simply walk away from their home, especially if they become unemployed. Fitch ratings recently estimated that up to 75 percent of the modifications now being done through the administration's Making Home Affordable program will re-default in six months to a year. I'm not talking about the old modifications, which were largely repayment plans that could actually raise monthly payments. I'm talking about the new mods, which lower monthly payments to 31 percent of a person's income. Not really a surprise. Many of these loans never should have been made in the first place and he banks are simply trying get whatever they can out of them.

We built something like an extra 3 million homes over trend growth, and those homes are going to have to be absorbed in the normal way, through growth of population and the economy. We "need" about 1 million new homes a year to take care of population growth and demand. Further, we have cut off home availability to buyers who are in the subprime category, whereas during the boom you simply had to have a pulse, even a lying pulse, to get a home for which you did not have a chance of actually paying the mortgage. Real Estate is likely headed to pre-boom levels, so expect prices from 1998 – 2000, still 30-40% lower.

Market Strategy: there are definitely places to make money without taking all the risk of the stock market. My suggestions over the last several months are still extremely attractive. Corporate bonds still offer fantastic yields even though the prices have moved up substantially and several high dividend stocks still pay very nicely even though those too have risen significantly. The current bear market rally, and make no mistake about it, it is a bear market rally should be used to reposition your portfolio to the one that you should have, not the one that your greedy alter ego made you believe you needed.

I can’t stress enough, be the expert or hire one. Work with someone that knows what they are doing. Whether it's me or someone like me, don't wait until it's too late. For a complimentary review or just a free 2nd opinion, call me at 916-925-8900.

Cheers -Keith

Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith at
916-925-8900 or Keith@KeithSpringer.com