Stock Market Rally Signals Economic Recovery

By: Money_Morning

Shah Gilani writes: The recent stock market rally may not be a bear-market trap or a “dead cat bounce,” but may in fact be the first signs of dust from an oncoming and unexpected bull stampede.

In the face of gloom-and-doom predictions, rapidly rising unemployment, and an imploding economy, the market's strong rally clearly anticipates a recovery in late 2009.

Is this just a bunch of bull?

While everyone seems focused on the economy hemmoraging red ink from the gash in the real-estate market, the broken bones of consumer demand and the unconscious state of banking and credit markets, only the stock market, and yours truly, seems to realize that the patient is being effectively triaged.

No, I haven't lost my senses; I've simply regained a sense of optimism. I never drank the poisoned Kool-Aid of markets past and am on record calling in February 2008 for investors to not only “sell everything,” but to “short everything, buy short-dated Treasuries and hold cash, not cash equivalents.” And just because I was right then doesn't mean that I'm right now; however, like back then, the traffic lights are flashing.

This time, however, they're green, and not bright red.

There's no doubt in my mind that the economy has farther to fall. Unemployment will hit double digits. Yesterday, the Labor Department announced that 5.6 million Americans are out of work , and that doesn't count those who've given up looking for work. On top of that it was reported that based on fourth-quarter numbers, gross domestic product (GDP) actually shrank at an annualized rate of 6.3%.

So, what are rallying markets telling us?

First of all, the U.S. Treasury Department may not actually have to spend the approximately $13 trillion in rescue programs teed-up to drive the economy. If investor perception that the U.S. Federal Reserve and Treasury plans might actually work, whatever the details end up being, then traders and risk takers will lead the investing crowd by getting in early before the herd follows suit.

That is exactly what we're seeing now.

Second, by some estimates, there is more than $9 trillion of cash sitting on the sidelines. I haven't heard a single market commentator – or so-called expert – illuminate the new market reality, which is that there are far fewer shares available to buyers than anyone realizes.

Since the Tech Wreck of 2000, we haven't seen any significant issuance of corporate equity. Since late 2007, for instance, the initial public offering (IPO) pipeline flow has been virtually at a standstill.

What hasn't been at a standstill since 2002 are leveraged buyouts. Low interest rates drove the leveraged buyout (LBO) business, which now goes by the more genteel name of private equity. Giant and once-thriving private equity shops such as KKR & Co. LLP , TPG Capital , Cerberus Capital Management LP , The Blackstone Group LP ( BX ), The Carlyle Group LP , Bain & Co. Inc. , and a host of other multi-billion-dollar buying machines took hundreds of public companies private by purchasing their outstanding stock with leveraged debt.

What will happen to most of these debt-laden “private” companies is another story, but the word “bankruptcy” will be featured prominently in the epitaph-like final chapter of most of their stories. The point, however, is that there are fewer companies and fewer shares for equity buyers to purchase. Add into the equation a share-drop in share prices to levels not seen in decades, and “Presto:” When institutional money and eventually retail buying comes back into the market, those trillions of dollars will be chasing fewer shares at low, low prices. It doesn't take a Wall Street rocket scientist to figure out that robust demand for cheap assets will fuel a rapid run-up in prices.

As the perception that this dead-cat bounce or bear-market rally has real legs takes hold, more committed buyers will come out of the woodwork, not wanting to miss the opportunity to average down or pick up top-notch household names at bargain-basement prices. [ For additional insights on the recent run-up in U.S. stock prices, please click here to check out a news-analysis story that appears elsewhere in today's issue of Money Morning .]

Increasingly positive market breadth and momentum technicals aside, what's fueling my optimism is that we're finally seeing a real effort to constitute meaningful regulatory reforms. Recent statements from President Barack Obama and Treasury Secretary Timothy F. Geithner echo my clarion calls for regulation of derivatives, market-moving hedge funds and run-amok private equity firms. This week, Geithner said he was pushing “not modest repairs at the margin, but new rules of the game.”

In addition to reigning in freewheeling leveraged wrecking machines, I see unequivocal echoes of my calls for a systemic regulator to monitor all players with the potential to single-handedly corrupt the markets , tightened and more universal accounting standards and a systemic watchdog to monitor threats to markets and the general economic health of the country.

Equally encouraging are statements that signal interest in adopting the “Spanish model” of requiring banks to set aside more capital in good times to cushion their equity and support regulatory reserve and capital ratios in bad times. Also, in a wink and a nod to stemming the moral-hazard implication of charging all banks the same Federal Deposit Insurance Corp. (FDIC) deposit insurance premiums, smaller and better run banks may not have to pony up premiums on an equal basis with insanely large and egregious and incompetently run money center universal banks.

The upcoming G20 meeting on April 2 will spotlight whether America will take charge in orchestrating a better international regulatory order by demonstrating its commitment to meaningful wholesale changes in it own feeble domestic regulatory apparatus. Clearly, President Obama had Treasury Secretary Geithner float several trial balloons this week, and clearly in the face of terrible economic data, the markets found a reason for increasing confidence.

It's just not possible to say enough about what effects appropriate, protective, and dynamic regulations can do for investor confidence in banks, markets and the safety of committed investment capital.

Unfortunately, as far as the economy, unemployment, embattled homeowners, businesses and devastated investors are concerned, the pain may not be over. On the other hand, if the tide of investor perception flows towards the potential for a safer investing climate and roots itself in anticipation of a stampeding bull run, all boats may rise with the tide a lot sooner than the gloom-and-doomers would have us believe.

I'm looking to the future.

Are you?

[ Editor's Note : Money Morning Contributing Editor Shah Gilani is a retired hedge fund manager and an internationally recognized expert on the credit and financial crises that continue to sweep the globe. More than 2 million readers have perused his analyses of deregulation, problems with the debt-rating process, and the bailout and stimulus plans put forth by the Bush and Obama administrations. Indeed, Gilani recently unveiled a banking-system repair plan that he says would fix the U.S. financial system - and at a much lower cost than the government bailout plan now being proposed.

Gilani is also the editor of The Trigger Event Strategist , which identifies profit plays that continue to be created by "aftershocks" from the financial crisis. Uncertainty will continue to be the watchword for at least the first part of the New Year. Little wonder, as the global financial crisis continues to whipsaw the U.S. financial markets in a manner that hasn't been seen since the Great Depression. It's almost enough to make you surrender and give up the investment game forever.

But what if you knew - ahead of time - what marketplace changes to expect? Then you'd be in the driver's seat right? You'd know what to anticipate, could craft a profit strategy to follow, and could then just sit back, watching and waiting and finally profiting from the very marketplace events you anticipated.

That's just what Gilani , a nationally known expert on the U.S. credit crisis, attempts to do with the Trigger Event Strategist . He has predicted five key "aftershocks" of the financial crisis that he says will create substantial profit opportunities for investors who know just what to look for, and how to play the. In the Trigger Event Strategist , Gilani uses these "trigger events" as gateways to massive profits. To find out all about these five financial-crisis aftershocks, and about the profit strategy they feed into, check out our latest offer . ]

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