The current bear market rally (or new bull market, if you appear on television), continues.  For the fifth consecutive week, stocks finished higher.  As of today’s close, the S&P 500 has shot up 27% in 25 trading sessions, a buying panic sparked by a string of news that is “less bad”.  Last week’s positive surprise came from Wells Fargo, which pre-announced much better than expected earnings on a day of light, pre-holiday trading.  With the steep yield curve, allowing banks to borrow from the Fed at 0.25% and invest in Treasuries and agencies north of 2.5%, one would think the banks could mint money.  But, at least until recently, investors expected loan losses to overwhelm these earnings.  With ongoing distress in the credit markets, it seems premature to assume the worst of the banks’ problems have passed.

The rally has carried the markets to the best five-week run since 1938.  The rally has been broad, with 85% of NYSE stocks above their 50 day moving averages.  Yet the rally has been led by many of the worst performers during the bear market, including banks and homebuilders, indicating that much of the rally has been driven by short-covering.  With the bulk of first quarter earnings set to be reported over the next three weeks, the market advance has left little room for error should companies fail to deliver upside surprises.

This rally has many of the characteristics of a bear market rally: a buying panic; led by the most heavily-shorted stocks; and embraced by many market participants proclaiming that the bottom is in.  We are highly skeptical of the sustainability of the rally, but of course are happy to take advantage of it.  In previous posts, we stated that long term investors with a moderate tolerance for risk should target close to a 30% allocation to equities.  This rally is affording the opportunity for those overweight equities to reduce exposure.  For those that have missed the rally, we recommend awaiting a correction from these overbought levels prior to committing capital to equities.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.