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Is the market reversal already happening?

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Market rallies do not always end with the trumpets sounding and horns blazing. A major reversal may look more like an oil tanker coming to a halt, and last week had most of the tell tale signs that you would expect to see.

The dollar, for example, bounced off $1.50 and closed higher. Bond yields shrank and bond prices rose. Equities sold off all over the world, though not in a disorderly fashion. Gold hit a new all-time high. Oil prices dipped.

Thanksgiving

With Thanksgiving coming up on Thursday next week this is expected to be a week of light volumes. But thin trading tends to exaggerate price movements, and if the downtrend has already started it could gain some momentum.

Has the longest and strongest stock market rally in history finally run out of steam, or is it just resting? In order to resume its upward march the US stock market requires some unexpected good news. How likely is that?

Is it not more likely that articles begin to point out that the emperor is actually walking naked these days, and has no clothes on.

First, the S&P sells on a price-to-earnings multiple of 88 after the recent financial results. That is a horrendous overvaluation. A reasonable p/e would be around 18-25. That leaves a 90 per cent downside!

Secondly, the outlook for GDP growth is lackluster in 2010. It is therefore vulnerable to setbacks, and most particularly the impact of a stock market decline that would undo much of the data pointing to a recovery being in prospect. The market has been operating as a positive feedback loop since March, it also works the other way around.

Thirdly, have markets not reached levels that would normally require a correction? Indeed, have they not overshot those levels, and now require a bigger than average correction?

No rate cuts

Fourth, with interest rates already on the floor where is the policy response to market weakness going to come from? The Fed will not be able to slash rates to counter a market rout. Will quantitative easing or printing money really rally confidence like a rate cut?

Fifth, markets are relying too much on emerging markets to lead growth in 2010. The data coming out of China and India is suspect and has a huge capacity to disappoint. Financial markets do not like such surprises.

At the risk of stating the obvious, the higher you go the harder you fall, and it is never different this time!

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Written by Peter Cooper

November 22, 2009 at 9:50 am

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