Double Bottom – This Bounce Should Have Legs – Be Patient.

March 19, 2008

The had one of its largest single-day rallies ever. It almost matched the one we saw a week ago, however, this one looks like it will stick.

A week ago Monday, the Fed granted banks access to $400 billion in US treasuries. They were required to pledge AAA rated mortgages as collateral for the loan. That news was well-received, but the ensuing rally quickly ran out of steam.

This privilege should have been extended to investment banks. Over the weekend we learned that Bear Stearns was in dire straits. Knowing that the failure of an 85-year-old financial institution would wreak havoc on the markets, the Fed quickly arranged a take over by J.P. Morgan Chase. They also lowered the discount window rate by .25%.

Financial stocks plummeted on Monday ahead of their earnings releases. As stock that had an $80 book value was sold for $2 and investors were not going to get burned again. As the numbers were released yesterday, the news was good and the liquidity was not an issue. Goldman Sachs and Lehman Brothers staged huge rallies and massive short covering took place. In the afternoon, the Fed lowered interest rates by .75%. The market took comfort knowing that progressive steps were being taken to protect our financial integrity.

This morning, the government took another step when it loosened strict capital requirements on Fannie Mae and Freddie Mac, allowing them to inject billions of dollars into the nation’s sagging mortgage market. There capital surplus requirement was reduced to 20% from 30% and this effectively added $200 billion of liquidity.

From my perspective, financial stocks and the market have formed a significant support level. We have successfully retested the capitulation low from January and if the market can rally above SPY 135, it will have broken a downtrend line. A rally above SPY 139 would signify that a minor horizontal resistance level has been overcome. These two events would strengthen the double bottom support level that has formed. If the market can sustain a rally, it can buy much-needed time to sort through this credit crisis.

The biggest news this week came from the financial stocks. Today, Morgan Stanley also posted a good number. I don’t believe that these stocks are out of the woods yet, but they have bought time to generate cash and avoid a crisis. Rising unemployment and high foreclosure rates will still plague earnings for this sector.

During the last quarter, if you backed out financial stocks, the S&P 500 stocks posted an 11% earnings growth rate. That is a very solid number and that should help to support the market.

For today, watch to see if the market can hold yesterday’s gains. Start looking for stocks that jumped yesterday, have a long term up trend and recently pulled back to support. I still like the commodity stocks, but they are selling off today. This has been considered a safe haven and money was flowing out of them and into other areas that have been beaten down. I view this as an opportunity, be patient. The long term fundamentals are still in place and I like energy and agriculture.

Keep your powder dry and spend your time on analysis ahead of the holiday.
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