Biggest Two-Day Stock Rally in Five Years a Fake

After falling more than 10% from the peak level this summer, the Dow Jones Industrial Average, S&P 500 and other major stock market indices finished yesterday with their best two-day showing since 2002. Enjoy it while it lasts, because I don’t expect this rally to continue much longer.

No investment trend goes up or down in a straight line. Bull markets have little dips along the way up. Bear markets have little rallies on the way down. The recent two-day rally by the stock market, in my opinion, is simply a stock market rallying from severe oversold conditions. Nothing more.

The big financial stocks have been severally “beaten up” by investors, as the fallout of the credit crisis continues. Big-name companies like Citigroup, Bank America, Merrill Lynch, Goldman Sachs and others have seen their stock prices practically nose-dive since the concern over the subprime mess spread into the general credit market.

>From May of this year to today, the Dow Jones U.S. Financial Index (comprised of the stocks of most of the largest financial institutions in the world) has fallen 20%. A rebound by the stock market (maybe “correction” is a better word) is normal from such oversold levels.

I’m looking at the market rally of the past two days as a classic stock market bear trap. Sure, investors are excited about the Federal Reserve cutting interest rates in the near future. But decreased interest rates will not be enough to heal the severe damage the economy has sustained.

Sales of existing homes fell in October for the eighth consecutive month. The median price of a home in the U.S. is down five percent from this time last year — ouch! Lending practices at the banks are tightening up, reducing liquidity in the economy. And as the U.S. economy gets closer to contraction, 2008 will likely be a most challenging economic year for America.

NEWSFLASH — Caisse de dépôt et placement du Québec reported yesterday that it has about $1.0 billion in exposure to the subprime market and $13.0 billion exposure to the troubled commercial paper market. We bring this to your attention because this is a fund located in Quebec, Canada – seemingly far away from the troubled U.S. property market. What large financial institution around the world has not been affected by the U.S. subprime mess?