I Have This Theory...

Rally Was Created Only to Dilute Baking Shares

Dear Bottarelli Research Member,

As I sort out this recent market rally, a light bulb just went off in my head. As you know, the stress test results were delayed on multiple occasions. And all the while, the markets kept rallying. The reason for this, in my view, is clear as day. I’ll offer you my entire theory below…

But first, I must admit: Sometimes, I can’t believe my own eyes. Yesterday, for example, the major markets put in a strong rally. Every single analyst interviewed on CNBC was ecstatic — even to a point that they appeared borderline giddy. “The worst is behind us, the bottom is in,” they all said in unison. Not a single market watcher issued any comments of caution or hesitation, and this struck me as very odd. Wall Street seemed to be dancing in the streets as the major market averages zoomed to a 0.6% gain on the 2009 calendar year. Stop my feet from dancin’.

These market watchers refer to the recent “strong” economic data as proof for our market recovery. Pending home sales rose 3.2% in March, they say. Yet they happen to leave out the fact that these sales are mostly foreclosures. And in the rare case it’s a legitimate home sale, who knows if the sale will actually go through at the closing table? After all, banks have a tendency to deny credit at the last minute nowadays.

Fed chief Ben Bernanke said on Capitol Hill today that the economy is bottoming and will turn upward by year-end. By now, I truly hope that you do not trust a single word out of this man’s mouth. Okay, forget Bernanke. How about Warren Buffet? He’s as reputable as they come, right? As you know, Buffet hosted his annual shareholder meeting over the weekend, and CNBC was there to cover the event. In all of the sound bites I heard, Buffet stressed that U.S. stocks look great, and some of his biggest gains have come during times of recessions. These comments gave everyone a warm and fuzzy feeling that things are just fine. But what CNBC failed to highlight was the fact that Buffet also said that all his companies show no sign of a bottom — and the economy continues to deteriorate.

I could go on and on with other examples, but you get the idea. So as it stands, we have a major market rally on the eve of news that the top financial institutions in the country (if not the world) will be forced to raise more capital.

Now here’s where my theory comes into play. You see, since the U.S. government has already infused so much cash into these financial companies, they’ll have no choice but to follow the government’s mandate and raise capital. Now, if the government is not going to give them any more money, the only way to quickly raise capital will be to announce secondary stock offerings. That’s why I feel this entire upside market rally has been completely orchestrated.

You see, banking stocks have just rallied very aggressively. As a result, their stocks carry a lot more value than they did two months ago. So, if banking institutions need to dilute the value of their shares in order to raise capital, they can do so right now, fulfill the government’s mandate, and still find their shares trading higher than they were back in March! What a brilliant concept!

The only patsies in the whole situation are those evil “speculators” who took a risk and bought into the banking stocks looking to make a quick profit (of course, I’m speaking sarcastically about how our current administration demonizes anyone looking to make money by trading stocks). The end result of this situation will be downside pressure on stocks. And for this reason, I’m biting down and holding onto our downside positions.

Three quick charts to confirm this view:

On a daily basis, the Dow chart looks like it’s breaking out. Don’t buy into this…

Because on a weekly basis, it’s crystal clear that we’re engaged in nothing more than a bear market rally.

Third, if you look at the CBOE Volatility index, you’ll see that it’s once again approaching a level that sparked a bounce. If a double-bottom is set, then you can expect some sizeable downside selling pressure on the way.

As always, I’ll continue to follow up with any alerts, as necessary. Until then…

Lock and load!

Sincerely,