It is too early to celebrate just yet

Last week, the Dow Jones Industrials and the S&P 500 both gained 1.4%. Both indices are well above their January lows and appear to be heading higher. Have the markets put in a bottom (as Jim Cramer happily exclaimed back in late January) and are now merrily on their way up? It is too early to celebrate just yet.
The Federal Reserve rate cut on 22 January, in response to the global market stumble of the previous day, followed by another cut at its regular meeting, has certainly cheered the bulls and led many to mark that day as a market bottom. The Fed, certainly, has given indication that it is ready to intervene and provide liquidity to bolster the markets. At the same time, many seem convinced that the latest wave of write-downs has accounted for all the bad news associated with the subprime meltdown and the credit crunch. It may be a little too early for that, too.

What we are currently experiencing is another bear market rally; financials, consumer discretionaries, and other sectors will likely continue to suffer in the coming months. Due to travels in Asia during these past several weeks, I have not been active in the markets -- this has provided me with an interlude during which to step back from the daily torrent of market news and its associated wild gyrations. As I return, I see little that leads me to believe that we have turned a corner...

It is, perhaps, stylish to be bullish. Over the past several years, the investing public has been conditioned to "buy the dips" as the market continued to rise. Based on the financial news, one would guess that the average investor is bearish. However, it is not so; Barron's quotes David Kostin, a strategist at Goldman Sachs: "Contrary to popular belief, short interest is low and decreasing, not high and rising." The put-call ratio, a contrary sentiment indicator, provides a bullish signal the more put trading exceeds call trading; for the S&P 100 index, the ratio for the week ending 8 February was 0.65, the lowest in many months. Memories are short. Buying the dips is somewhat counter-productive when markets continue to decline.

Certainly, many sectors -- most notably the financials -- have already suffered significant declines and are in bear market territory. So now they must come up, right?

Perhaps being bearish is the true contrary position?

Why do I remain pessimistic? The subprime crisis and the resultant credit crunch are far from over; the worst should actually come this year. RealtyTrac calculates that 1.8 million mortgages are scheduled to reset in 2008 and 2009. At the same time, despite write-downs, companies have been notoriously slow to accept the full extent of losses associated with these developments and other aspects of the credit crunch. Far from being over, the bad news continues -- witness UBS' report of a $13.7 billion write-down this past week. Philip Finch, a UBS analyst, estimates that global banks face $203 billion in further write-downs. With billions of dollars of potential losses still unrealized, the true value of assets on the books of financial institutions remains open to question.

Beyond the financial sector, though many P/E ratios currently seem attractive, much of that depends on the denominator. If earnings disappoint, apparently cheap stocks will become much less so. At the same time, consumer confidence continues to ebb as the US domestic economy slows. Whether we enter a recession or not, domestic growth and corporate profits will slow.

As a result, I remain broadly bearish on the domestic stock market and especially suspicious of the financials.

Where should one look for profits now? Commodities, such as grains and gold, offer opportunities for further appreciation, as do their related stocks. Agnico Eagle Mines (AEM) interests me, though I have yet to purchase any shares. Energy exploration also offers opportunities for long-term appreciation.

At the same time, I continue to maintain my long-term core holdings and to build my "wish list" for beyond this bear market. Some financials have been unfairly punished and will undoubtedly prove good investments; though I think this punishment may yet continue for several months, I am waiting for the opportunity to purchase American International Group (AIG) and additional shares of Lehman Brothers (LEH), as well as some regional banks. Railways, such as Burlington Northern Santa Fe (BNI), are also interesting.

In time, the markets will turn. I cannot predict with any accuracy when that time will come, but I feel it is still too early to begin shopping now. I do not expect to call the bottom, but I am not in a hurry to catch any falling knives, either.