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Tuesday, April 1, 2008

Writedowns + Contraction = Rally???

OK, so UBS writes off $19 billion and cans the chairman. The ISM survey shows continued contraction in manufacturing, specifically declines in new orders and increases in materials prices. Lehman says they have no liquidity problem but they feel it is worthwhile to dilute present shareholders by issuing preferred shares.

Last week this news would have sent the markets into a tailspin. This week it instigates a rally in stocks and the U.S. dollar as well.

So where does that leave us? Looking at the S&P 500, it seems everything is set for more gains. Today's action takes the index significantly above its downward sloping trendline and its 50-day moving average. Volume was good though not as heavy as bulls would have liked. We saw an accelerated rotation out of bonds and commodities and into the most beaten down sectors - financials, retailers and tech. Market sentiment is extremely positive - all news is good news.

What could hold us back? There is a resistance level in the 1390 range, just a little way above today's close. This level is based on the lows made in March and August of last year. The index has twice tried to make a significant move above this level and failed both times.

We have a long way to go before we reach the 200-day moving average which, by the way, has clearly turned down starting in the beginning of February.

And finally, there is the matter of fundamentals. I've already mentioned the ISM survey. At 48.6 it was better than expectations but just a fraction above last month's level. In any case, being under 50, it still represents contraction in the manufacturing sector. The construction industry also registered continued declines. Automakers reported sharply lower sales. We've seen consumer spending flatten. Morgan Stanley is out with a report stating we are in the worst banking crisis in 30 years. Then there are the proverbial "shoes" yet to be discovered but ready to drop at an inopportune moment.

Today, none of that mattered. In the spirit of the day, I can't wait for Citi to report another $14 billion writedown, as Goldman expects it will. I'm sure the markets will rocket higher again.

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