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Excerpt from the HS Dent Newsletter

Posted At : February 16, 2009 1:31 PM

The market has violated every technical rule in the book and will likely continue to given the forced and panic selling from hedge funds. What we have here is the $2 trillion hedge fund industry blowing up and melting down after leveraging money as much as 30:1. That is why the selling is so irrational and persistent. This crisis began with the slowdown in housing, but its real cause was a new class ofmortgage (CMO) and debt-backed (CDO securities that were rated AAA by the rating agencies, then leveraged heavily by hedge funds and investment firms to take advantage of their “quality” and low volatility, then insured through credit default swaps (CDS) that were unregulated (and hence had questionable assets backing them), and then those CDS derivatives were traded and leveraged growing to a massive market of $60 trillion dollars. Almost no one saw this coming as the securities that underlay this whole leverage scheme were AAA rated. But they shouldn’t have been and now the whole financial system is melting down.

Many indices from the S&P 500 to the Nasdaq to the EEM (emerging markets) have made new lows, although the Dow held above its 10/10 lows of 7,882. The Nikkei in Japan fell below its 2003 lows before rallying. Hopefully we have a seen a bottom for months to come and we continue to rally towards 12,000 or so well into 2009. If we rally to the most likely near term target of 10,000 – 10,100, that could represent the 4th wave of a broader A-wave that could see a final bottom closer to 7,000 if there is bad news ahead on the economy, or more bank crises. The strongest support for U.S. stocks is the 7,200 – 7,400 area where the 1998, 2002 and 2003 bottoms occurred. There was also a minor low in late 1997 close to 7,000, so the range is 7,000 – 7,400 for very strong support. All of the sharp rallies thus far have merely been short squeezes, which was typical in the 1929 – 1932 crash. For now, there is a better chance that we have seen the lows for now and we get a continued, but choppy rally for months ahead.

The irrational panic selling in the stock market is not coming as much from normal investors and mutual fund managers as in the early 2000s. It is coming from highly leveraged hedge funds that are incurring huge losses and redemptions which forces them to sell all of their good stocks as well to get liquid.

If the market does end up bottoming on 10/10 at 7,882 on the Dow, then an eventual recovery from an increasingly successful Treasury plan will be the likely scenario. And then inflation pressures, rising interest rates and commodity prices will be very likely and ultimately defeat such a rally. The stock market could advance more to 12,000 – 13,200 in that scenario and into spring or even summer (March – September). That will give investors a chance to sell stocks at more attractive prices and to unload real estate in a slightly better market, as real estate won’t rebound for many years!

Regards – Keith Springer

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