Bear market rally or the start of an equities recovery?

(September 8, 2008) Equity markets in North America have staged a significant rally this morning following the U.S. government’s move over the weekend to take over beleaguered mortgage lenders Freddie Mac and Fannie Mae. While Fannie and Freddie have seen its share prices collapse and Sovereign Bancorp, a significant holder in Freddie Mac, has dropped over 10%, this move appears to have shored up confidence in the housing market and banking system.

In particular, this move appears to have lit a fire under the homebuilders, home improvement retailers and some of the regional banks. Some of the leading advancers have included Lennar, up 11.5%, Centex, up 9.4%, KB Home, up 9.8%, DR Horton, up 6.6% and Lowes, up 6.7%. After steadily declining through 2007, homebuilders such as Lennar had stabilized earlier this year and had been consolidating in recent months. Today’s rally suggests that the sector may now be poised to break out to the upside.

Looking at the broader indices, however, it remains uncertain at this point whether this rally is another dead cat bounce or the start of something new. Looking back at the last bear market in 2000-2002, note that over that period, the Dow Industrials staged several large, sharp rallies from oversold conditions, only to find that after a few weeks or months, investor malaise returned and the index ended up at even lower levels.

So far, what this rally appears to have done is claw back some of last week’s losses. Indices, however, remain well short of resistance levels where rallies failed, such as 11,800 for the Dow and 1,300 for the S&P 500. Should resistance continue near these levels, it would suggest that investors may still be concerned about the impact of seemingly weak economic conditions on the outlook for corporate earnings. Also, investors may still be concerned that the problems in the banking system that led to this bailout may still be affecting other financial institutions and that there may be additional shoes waiting to fall on investors’ heads.

Should indices break through the levels noted above, we could see a recovery trend similar to the one that occurred in the spring, which could drive indices back toward a retest of their May highs near 13,000 for the Dow and 1,425 for the S&P. Should current support levels, near 10,800 for the Dow and 1,200 for the S&P fail to hold, however, the Dow could retest its 2006 low near 10,650, while the S&P could test 1,160, a key long-term support/resistance level. As it appears that the S&P may have completed a double bottom near 1,200 last week, and considering that equity markets have traditionally tended to reach their lows for calendar years in the September/October time frame there does seem to be some technical support for a potential rally into the autumn.

While equity indices still appear to be range bound, commodities also appear to be starting to consolidate after recent declines. Crude oil, for example, has been trading between $104/bbl and $110/bbl, while natural gas has been trading between $7.00/mmbtu and $7.85/mmbtu. With Hurricane Ike heading for the Gulf of Mexico, there could be some volatility this week on concerns over potential damage, but investors might recall that the trading around Hurricane Gustav earlier this month showed that this volatility can cut both ways.

Other commodities that had been under pressure of late also appear to be stabilizing. Gold and silver, for example, recently retested their August lows and appear to have stabilized in the $780-850/oz and $12.00-$14.00/oz range respectively. In grains, meanwhile, wheat appears to be consolidating in the $7.50-$7.80/bushel zone while corn seems to be stabilizing near $5.50/bushel.

With commodities stabilizing, renewed interest in the financial services sector appears to be driving Canadian markets higher. Leading advancers among financials in Canada today include: TMX Group up 4.9%, CIBC up 4.4% and Sun Life up 3.8%. Meanwhile, Rona has gained 3.2%, apparently trending higher along with its U.S. competitors. Having completed a bear trap just below 750, the S&P/TSX 60 Index seems to have moved back into its 780-820 trading range.

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(09/08/08)