Be careful of buying into yet another bear rally

by R SIVANITHY (30 Nov)

SINGAPORE - Once the month-end window-dressing of the major indices seen last week is over with (probably early this week), it's very likely that Wall Street and markets in this part of the world will revert back to reacting to the dismal economic and earnings news that's being issued, news that's not expected to be good.

On Monday for example, the US market will have to ponder the release of the November Institute of Supply Management (ISM) manufacturing report. Independent research firm Ideaglobal over the weekend had this to say about the report: 'We expect the headline measure will continue pushing lower in Nov to 38, declining from 38.9 seen in Oct.'

'The manufacturing sector has seen consistently weak results thus far in 2008...thus far in Oct, the headline measures for both New York and Philadelphia painted a very grim picture for manufacturing in the coming months...overall, the lack of new domestic business activity will continue to overshadow declining external demand for US goods and services throughout the remainder of 2008 and into 2009.'

It also added that the US Treasury bond market has fully priced in a deep contraction in Q4 GDP and a very weak start to 2009.

Investors should not forget the not-insignificant problems faced by the US auto industry and the very real likelihood of Detroit, like Iceland a couple of months ago, going bankrupt.

In addition, the US housing market shows no signs of recovery and could in fact be worsening.

Alan Abelson of US newspaper Barron's reports in the Nov 24 issue that the latest victim is commercial real estate.

'The cost of buying protection against default of commercial-mortgage-backed securities has shot up in a notable hurry. The index that tracks such things has more than doubled since (Treasury) Secretary Paulson changed gears on the use of TARP (the US$700b Toxic Assets Rescue Plan that was scrapped recently)', wrote Mr Abelson.

'The yield on such paper with the highest credit rating is now a startling 12 percentage points above the yield on Treasury securities of comparable maturity.'

Our guess is that the Wall Street's bounce last week, supposedly in response to news that the Federal Reserve is to provide an US$800b lifeline for consumer debt was most probably mainly short-covering-induced, aided by a desperate attempt to window-dress the performance of a dismal month and/or year so far.

This process has been also assisted by 'buy' calls from some quarters on the basis that 'markets are oversold' (which in itself is no reason to buy when you really think about it if there are no earnings to speak of) and that all-time laughable classic, 'Asia is decoupled from the US and Europe's problems', which is a hackneyed soundbite trotted out every few years by a financial community that got it spectacularly wrong in 2008 and which can easily be consigned to the scrapheap by pointing out that throughout 2008, Asia has performed much worse than the US or Europe.

Looking further ahead into 2009 though, and you'd have to admit that with the Fed about to run its printing presses at full tilt, the sheer weight of US dollars being printed and thrown at the problem must sooner or later reflate the economy.

As an interesting side issue, it's worth noting that if the Fed were a commercial lender, it would be bankrupt by now. Elsewhere in Barron's Nov 24 issue it is reported that the Fed's capital adequacy ratio is now under 2 per cent, the threshold considered dangerously low.

As former president of the Cleveland Fed Lee Hoskins is quoted saying 'The Fed has violated two principal tenets of central banking - don't lend to insolvent institutions and don't lend on anything but the most pristine collateral'.

Our guess is that any recovery though, if it occurs, will only appear in late 2009 at the earliest. Until then, there will be the odd bear rally to provide some solace for battered bulls, bear rallies like the one seen last week. Investors should tread carefully or risk being caught in yet another bear trap.

-Research Report by R SIVANITHY (30 Nov)