Is This V-Bottom For Real? (C, FRE)

It is always a wonder when the markets go from horrible to wonderful in two mere days.  If you asked traders, institutions, and brokers last week (or even Monday) what to expect, you would have probably gotten the answer of "major volatility" as the problems continue to be painfully worked out.  Here are today’s levels as of about 1:45 PM EST:

DJIA          13,251.00 (+292.56;+2.26%)
S&P500     1,461.48 (+33.25; +2.33%)
NASDAQ   2,652.35 (+71.55; +2.77%)
10YR T-BOND 4.025% (+0.081%)

In less than two trading days the DJIA is up a touch more than 500 points.  We don’t mean to sound like spoilers, but this seems almost too good to be true.

Two days ago we didn’t have the news that Abu Dhabi was taking a $7.5 Billion stake in Citigroup (NYSE:C) and Freddie Mac (NYSE:FRE) hadn’t taken initial steps to raise capital and slash its dividend.  Two days ago we hadn’t fully digested the Goldman Sachs note increasing the chances of a recession ahead in 2008.  Now the markets seem to have figured out through the economic data tea leaves that despite the Fed Governors trying to caution against rate cuts that the yield curve was indicating the FOMC is a point behind.  Rate cuts from here still put the US Dollar at a major risk.

We are still concerned that rate cuts alone aren’t going to help and we think that there needs to be some pain before pleasure in 2008.  The consumer and borrowing sins of the past still have to work themselves down and that may be another 6 months or much longer.  The bad news from the banks and financial institutions will not have suddenly ended.  Housing isn’t expected to get any better in 2008 by most.

At the end of the day on Monday the CBOE Volatility Index (the "VIX"), the fear index, approached a reading north of 28 after seeing north of 30 just two weeks ago.  It is now back to 24, which is still high but not for recent weeks.

The only way to know a V-Bottom ever was truly formed is by seeing it after the fact.  The good news is that maybe the markets can continue running back up and maybe Monday’s closing prices were a future support level.  But it seems like we need to see one ugly and awful day again before the sellers get flushed out completely.  Maybe that ugly and awful day is only a retest of Monday’s levels and maybe it is only a retest of levels higher.

But it still seems too soon to declare the malaise entirely behind us.  The flip-side is of course that at some point the "less bad news" starts to be treated as good news.

Jon C. Ogg
November 28, 2007