We’re in a Breakout, But Is It Just
Another Bear Market Rally?

While we’ve had an uptick in manufacturing, retail, and housing starts, economic data are not strong enough to get investors to participate in the stock market. There remains a sense of gloom hanging over the economy with the very real possibility of a U.S. recession happening again next year. If this happens, then it’s fair to conclude that current stock market trading action is really just a bear market rally. In a sense, I think the same thing is occurring in the Main Street economy—it’s a bear market rally in economic activity after a sustained period of weakness.

Several times this year, we had a situation where most investable assets like the stock market, oil, gold and other commodities were trading in lockstep, particularly to the downside. It’s likely we’ll see this kind of trading action again in 2012, as investors come to terms with very slow economic growth. As investor sentiment fades, we could see another major migration to cash and bonds. It’s similar to the “forced liquidation” that Jim Rogers often refers to; and this makes it very difficult to formulate a portfolio strategy at this time.

The stock market today is experiencing a bear market rally, based on events regarding the eurozone debt crisis. As is the case with virtually all politicians, Europe is likely to get only temporary solutions, which unfortunately sets the stage once again for new shocks to the U.S. stock market. With this backdrop, stock market investors need to play a very strong defense over the near and medium terms.

The U.S. economy has proven over time to be exceedingly quick at correcting shocks to the system, but today we’re in a new paradigm—one that’s defined by debt. And, as we all know, getting out of debt isn’t that easy. At the sovereign level, even reducing the rate of growth in government debt has yet to be addressed. This is why I’m thinking that the stock market (which is in a breakout bear market rally right now) could tick higher going into the New Year; with growing risk of another forced liquidation of assets. Stock market investors don’t need to be buyers in this market and they don’t need to rush into commodities either. A bear market rally can suck investors in with the best of intentions, but the fundamentals aren’t yet good enough to go all in. Don’t forget; stocks have been in a bear market since 2000. A bear market rally is now commonplace.

We just completed a correction in the stock market (August to October 2011) and equities are trying to make a breakout right now. (See Investment Risk Going Up—It’s the Kind of Market Where Anything Could Happen.) This bear market rally might have legs until the end of the first quarter next year. I might be wrong of course, but my gut tells me that the current action is a trap. There is more reckoning to be had in the global economy, the stock market, and commodities before a new business cycle can begin.