The Confidence Gap Helps the Bears

10/20/2009 10:02 am EST

Focus: MARKETS

Curtis Hesler

Editor, Professional Timing Service

Curtis Hesler, editor of Professional Timing Service, says the public is losing confidence in the markets and the economy, and that could be bad news for stocks.

I don’t believe that the public has yet lost faith in our currency in their small, walk-around world of day-to-day economic activity. The public is losing confidence in the future, however. They worry about their jobs and income. Their trust in the soundness of banks and our financial system is not as strong as it was a few years back. This unease should not be ignored.

All the while, commercial banking is suffering from a confidence gap, and rightly so. Banks are trying to elevate the equity side of their balance sheets. They can only do this by curtailing lending and increasing fees. However, making loans is what they are in business to do, and lending is the grease that lubricates economic growth. Consider that 9%of real estate loans still on the books are delinquent, and this number is growing.

I do not think the deleveraging process is anywhere near over. The movement away from debt is multi-faceted. Banks are pulling in lending and are trying to shed bad loans. Credit limits are being lowered on all fronts. The consumer, fearing the future, is pulling in his horns. The process severely limits American economic growth potential.

As we anticipated earlier this year, the stock market has staged a spectacular rally. The Obama rally has caught the imagination of investors who are now thinking “new bull market.” How long can the illusion of a new bull market last? It has already lasted longer than I expected, but October is traditionally a very bad month for stocks, even during good economic times. Regardless of the progress it made in September, the market is still overbought.

The next down leg has the potential to be abnormally savage. My work continues to forecast new lows in the averages—below those set last March—as the next bear phase develops. Those expressing last spring that they would sell if the market rose 40%will likely hold through the coming weakness.

It is normal for the crowd to hold until the ultimate bottom comes in the bear market. I don’t see that bottom occurring for some time and, more importantly, not until severe damage is once again inflicted on the average guy’s portfolio. The next bear leg is not going to build confidence on the part of businesses, or consumers, or investors.

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