03/27/2010 05:12 am ET Updated May 25, 2011

How Many More Kicks In The Groin?

Go figure this balmy stock market. A week ago, investors were beaming. No wonder. It looked like we were seeing a replay of last July's running of the bulls of Pamplona as bullish sentiment in the stock market continued to rise, while fear showed additional signs of evaporation.

The spreading bullish fever is easy to understand, given the market's blistering performance -- up nearly 70% since its low of last March (about 6,500 on the Dow) -- a nine-month rise that has been devoid of any meaningful interruption along the way.

But suddenly, an unexpected kick in the groin, as the major averages got slammed in last week's final three trading sessions, highlighted by a wicked 552-point drop in the Dow.

Money manager Arnold Silver of Los Angeles-based A. Silver Associates considers the drop ominous. He views it as a case of reality catching up with wishful thinking, a recognition of growing turmoil in Washington, a President in hot water, and he sees lower equity prices ahead, maybe another 5% to 7% decline.

"It seems to be a propitious time for everybody to cut back on underperforming stocks before the losses become more substantial," he says.

The market's sudden selloff is attributed to a number of factors, among them a couple of new worrisome developments. They are the President's bank bashing accompanied by some proposed new bank reforms (such as prohibiting banks from forming hedge funds, private equity funds and trading securities in their own accounts) and China's plans to cut back on bank lending, which could slow its economic growth.

Adding to the market's woes, weekly jobless claims have risen for the second straight week, a number of recent earnings reports have come in below some Wall Street expectations, retail sales seem to be turning sluggish again and housing remains a horror show.

The President's pursuit of banking reforms even worries some of the bulls. One of them, market guru Elaine Garzarelli, says "if new bank regulations are passed, we could see a large correction."

Similar concern is also voiced at the possibility that Federal Reserve chairman Ben Bernanke might not be reappointed for a second term amid some congressional opposition. Most market observers I talk to figure he's a shoo-in for another term, but the idea that maybe he won't be adds to the list of concerns. Silver, for one, thinks if Bernanke is scrapped, "the Dow is easily a quick 200-250 point loser."

The key question, of course, for the nation's more than 80 million stock investors is how many more kicks in the groin are lurking. Veteran investment adviser Martin Weiss of Weiss Research in Jupiter, Fla., for one, is convinced the kicks are far from over because the days of the rally -- which he calls "a bear market rally" -- are numbered.

Why so? For starters, he notes, the market expects dramatic profit improvement, which is unlikely because the increases we've seen so far from last year's depressed levels have hardly been inspiring.

Further, he points out, the economic recovery we've seen so far has been bought and paid for by Washington. But those days, he believes, are history. If the President pushes for more stimulus to further beef up the economy, Congress, he says, is apt to say no because the public mood has shifted dramatically. The public, he argues, is now more concerned about the budget deficit than the economy; it now prefers restraint rather than fiscal stimulus.

Weiss also contends the causes of the banking crisis have not been cured, but made worse by compounding the problems, which raises the possibility of another debt crisis. In particular, he points to the "Garden of Eden environment" Washington has created for the banks, especially for Goldman Sachs, by giving them a blank check to speculate and take more risk. Likewise, the Fed keeping interest rates at near zero percent, providing banks with cheap financing for risk-taking. Yet another criticism: allowing Morgan Stanley and Goldman to convert into commercial banks and take more risk with government guarantees.

"The large bank, which is operating in a no-fail environment, is the big elephant in the room, but no one is addressing it," Weiss says. He's especially negative on the mega-banks, notably Bank of America and Citigroup, which, even if the government keeps them alive, he points out, can still lose money and produce stockholder losses.

"It's either fix the banks or brace for another crisis," says Weiss.

Another wary pro, Charles Biderman, CEO of West Coast liquidity tracker TrimTabs Research, offers a number of reasons why he thinks the recent selloff in stock prices is a prelude to an even bigger market decline. Chief among them:

  • The idea we're in a economic recovery is highly questionable because the single most important ingredient of such a recovery -- signs of a rebound in wages and salaries -- is conspicuously missing.
  • Consumer borrowing is plunging. Last month, total consumer credit at commercial banks dropped18.3 billion or at a 15.1% annual rate from year-earlier levels. How, Biderman asks, can the economy grow when such borrowing is falling. The answer, he says, is that it can't.
  • Mortgage delinquencies show no signs of slowing, while the latest figures show 6.2 million mortgages are delinquent.
  • Tight credit, falling wages and high gas prices are slamming the consumer.
  • Corporations and corporate insiders, Wall Street's so-called smart money, remain aggressive sellers of stocks.

Biderman, incidentally, received a fair amount of press coverage when he charged that the market's sharp rise was a reflection of manipulation of stock index futures by the Fed and the U.S. Treasury.

At the recent running of the bulls in Pamplona, a man was gored to death. The bottom line here: regardless of what you hear from the endless number of bulls, not everything is coming up roses. So beware, you could easily get financially gored.

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