No, the bear market is not over! (page 1 of 2)

There are, however, a number of factors, which suggest that the present rally is unlikely to be the beginning of a new bull market, but rather a treacherous bear market rally, which will be followed by renewed weakness in 2003.

From the October 10th low, the market has generated three opening gaps. Similarly a large number of stocks including IBM and GE gapped several times during this rally. Now, from technical analysis we know that most gaps are eventually closed unless they are breakaway gaps after a long base building period - ideally a base, which took several years to build.

The problem with the recent gaps is that they came merely from an oversold position, but that most stocks had not been establishing any base formations at all before they gapped on the upside. In addition, the rally was accompanied by declining volume and relatively poor advancing volume compared to declining volume.

Another concern I have is that investors, technicians and strategists were very quick to turn bullish. In fact at around the time the rally began, a Merrill Lynch survey found that 75% of fund managers thought world equities to be oversold.

Moreover, whereas only 17% of fund managers perceived equities to be overvalued, 29% thought them to be 'fairly valued' and a full 51% to be 'undervalued'. Asked whether in 12 months time the markets would be higher or lower than at present, 28% of fund managers answered that the market would be 'much higher', 48% 'slightly higher' (single digit returns), while only 9% responded that the market would be 'slightly lower' and just 6% that it would be 'much lower'.

These sentiment surveys and the still low cash positions among mutual funds certainly do not reveal any capitulation at all on the side of investors - an event, which usually coincide with 'major' bear market lows, such as we had in 1974, 1982 and 1990. I may add that I attend every year numerous investment conferences as a speaker and my sense is that the majority of investors is far more concerned about missing the next bull market than about losing another 40% or so of their capital as a result of a continuation of the bear market.

But technical and sentiment factors aside, there are also some fundamental reasons for remaining cautious. Since the US bear-market began in March 2000, the only excess, which has been purged, is the high tech and telecommunication stock market bubble. However, other excesses and imbalances, which the late 1990s brought along such as an excessive credit expansion, a declining savings rate, large trade and current account deficits, and over-leverage in the corporate and consumer sector have so far not been corrected, as was always the case in previous recessions.

In fact, over the last two years these imbalances have actually become even worse courtesy of Alan Greenspan's artificially low interest rate policies, which supported the refinancing boom in the housing industry and allowed the consumer to go deeper and deeper into debt in order to sustain his consumption.

The problem with this situation is that the consumer is now highly indebted and that there is no pent up demand at all, which would support a strong economic recovery. Don't forget that in previous recessions, consumers cut back on their consumption, purchased fewer homes, increased their savings rate and, therefore, rebuilt their balance sheets. And by cutting back on their consumption consumers, therefore, built a pent up demand, which usually acted at some point as a catalyst for an economic recovery.