As we progress into April, the current bear market rally is now four weeks old and has thus far posted some impressive gains off the March 9 intermittent low. Notice I said “intermittent low” and not “bear market low.” There’s a world of difference between a secular bear market low and a bear market rally; this is not the start of secular bull market similar to 2003 or 1981.

Despite big gains for global averages over the last four weeks, investors should remember that the Dow Jones Industrials, Dow Transports and the S&P 500 Index violated important support levels on March 8, hitting new bear market lows. This alone is a reason to be cautious since it portends to major technical damage done to the broader market; a bear market rally is not surprising considering the extent of protracted selling that has occurred over the last 20 months.



Since March 9 the S&P 500 Index is up a cumulative 27%. The S&P 600 Index of small-caps has surged 36% while the Dow Industrials has gained 23.5%. The economically-sensitive Transports Index, a good gauge of future cyclical economic activity, has rallied 39%. These results are indeed impressive and more investors are chasing this rally.

As expected in a big counter-trend rally, the CBOE VIX or volatility index has crashed 55% since hitting an all-time high in late November and is down 9% in 2009. On Thursday, the VIX broke important support levels declining below 38.50.

Yet while this celebratory mood has ignited hopes for a sustainable new bull market after three previous failed attempts since October 2007, investors should note that high quality credits or investment grade debt spreads have not declined since March 9. To be sure, riskier credits like junk bonds have seen their respective yields fall over the last four weeks while areas of the credit market that are currently engaged by the Federal Reserve – mortgage agency debt – have seen their yields fall, too.

I point to previous bear market rallies similar to the current event unfolding since March as evidence that investors are too optimistic; the scope for a sustainable recovery based on renewed domestic consumption is elusive as consumers rebuild balance sheets and continue to cut spending. Also, in the absence of a credit-fueled import binge, the United States trade deficit is collapsing since Q4 – not a bullish signal since it confirms a crash in net demand.

If not the United States, then who will replace America as the buyer of the world’s goods? I can’t think of a single country in a position to assume this role.

The combined sum of U.S. and foreign government fiscal spending will be enough to provide a boost to economic growth over the next several months and this probably explains why equities are finally rallying since March; yet it is important to remember that government induced consumption cannot indefinitely replace consumer spending – especially as the unemployment rate continues to skyrocket. The United States and most of Europe will eventually require more fiscal spending.

Previous bear market rallies in the 1930s are an instructive theater to the current credit inflicted crisis since late 2007. This is a credit bear market, an event that rarely occurs in an investors’ lifetime and, therefore, should not be underestimated.

The damage to the financial system is enormous as credit destruction continues to drain households, businesses and even government resources. Proof of the latter point is the state of credit default swaps traded to protect investors against government debt default. This spread remains elevated for many sovereign borrowers and has even risen for U.S. Treasury’s and German bonds over the last three months. Governments are piling on too much debt.

Meanwhile, let’s review once again what happened during the first three years of the Great Depression when stocks also posted big short-term rallies. The Dow logged several big bear market rallies following the initial October 1929 crash.

The first such rally occurred in 1930 (+48%) followed by three other big short-term gains in 1931 (+23.4%. +27.6% and +35%) and finally another rally in 1932 (+24.6%) before the Dow finally hit a bear market low in June 1932 at 41.22.

The stock market, of course, can continue to rally even though we are now heavily overbought over the short-term. But as previous rallies of this magnitude have clearly shown since October 2007, it’s usually the best time to consider reverse-indexing or betting against the market as we approach the top end of this trading range. In my eyes, this rally should be sold, not accumulated.

“Sell in May and go away…”

That famous stock market adage might be especially true in 2009.