Are stocks about to crash?

Friday, May 14, 2010
By Paul Martin

Colin Barr

When does a big market rally spell doom for stocks? Right now, says one bearish commentator.

Gluskin Sheff economist David Rosenberg says in a note to clients Thursday that it’s time to “take chips off the table.” He says stocks have risen too far, volatility is rising and the economy remains too weak to support current prices.

None of this is exactly shocking, given that Rosenberg has been warning for the past year that stocks looked bubbly given high unemployment and other signs of economic slack. Since stocks bottomed in March 2009, he has been saying that they were overvalued by as much as 35%, based on indicators such as earnings multiples.

But now Rosenberg contends the return of volatility, which measures how much stock prices tend to move in a given day, confirms that stock market bears will soon roar again. Despite his wrong-way bets of the past year, Rosenberg has some credibility because he was among the few who saw a recession as inevitable way back in 2007, before the full extent of the financial meltdown became clear.

“The most valuable information contained in last week’s intense volatility, underscored by the 400-plus point bounce in the Dow, is that it’s time to take chips off the table and brace for the breakdown,” Rosenberg wrote Thursday.

Most of the previous single-day rallies on the Dow exceeding 400 points took place in the midst of steep long-term declines, Rosenberg contends.
“There have been no fewer than 16 such rallies of 400 points or more in the past, and 12 of them occurred during the brutal burst of the credit bubble and the other four took place around the tech wreck a decade ago,” he writes.

Indeed, the first two 400-point gains took place in 2000 and 2001, amid the collapse of the tech bubble. Two more took place in July 2002, as stocks tumbled toward their post-9/11 low in October of that year. There were 10, count ’em, 400-plus point gains in 2008, when all hell broke loose and the stock market lost more than a third of its value.

Rosenberg’s argument is on shakier ground with the 497-point gain last March, which, after all, came at a time when stocks were 3,000 points below their current level, and perhaps with this week’s gain. While the “burst of the credit bubble” label may still stick, who knows for sure what comes next in the age of free money?

But there will be plenty of time to debate that later.

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