The market, increasingly hungry for good news, took some surprising numbers on housing (new starts up) and turned it into a nice rally on Tuesday.
Will it hold? Are we over the worst?
Unfortunately, the answer is probably no. Things are still tough out there and those problems won’t go away soon.
However, as we see more short rallies, even if they are followed by new dips, the more confident we can be that the bottom is closer than it was three months ago.
When we look back at this period and identify the market’s bottom (not the same as the economy’s bottom), it will be easier to see small hills amid some deep valleys.
The true market bottom may be months away (no one knows for sure), but the market won’t begin a reversal until we see more three, four and five day rallies.
Supply and demand is a brutal ruler of the stock market (and all other markets, for that matter). As long as there is much more supply than demand, the market will flounder.
Demand can’t possibly absorb all the supply on the market, which is another way of saying there are many more sellers than buyers.
The housing market faces a similar situation. The supply of existing houses (foreclosed, distressed and regular sales) will be a drag on many local areas for years to come.
However, as these houses are bought and occupied, housing prices will begin rising again.
Although the analogy is not perfect, the concept is the same for stocks.
Foreclosed houses will sell when the price is low enough to attract buyers back into the market. The same is true of stocks. Buyers will return to the market when stock prices are so low the risk of loss is minimized.
What the financial crisis is doing to housing and the stock markets is wringing out the air, which created bubbles in both markets.
Investors and homeowners may not enjoy seeing their assets marked down in value, but this has to happen before buyers will feel safe enough to return to those markets.
The markets can fool the supply-demand paradigm for a while, but sooner or later S&D exerts pressure to make things right.
The housing and stock markets won’t return to a growth mode until the danger of further losses diminishes. When buyers believe most of the extraordinary risk has dissipated, look for strong growth opportunities in both markets.
For investors with a long time period and a stomach for risk, the potential rewards are significant.
