David Gaffen

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Hair of the Dog Rally

September 17, 2009

The old lore about the best way to cure a hangover is with a few more nips of whatever it was you were imbibing the previous evening, commonly known as “hair of the dog.”

The extension of this rally in stocks and just about every other asset identified with risk feels like a hair-of-the-dog situation. Between 2003 and mid-2008, easy flow of capital facilitated revelry in stocks, emerging markets, real estate, bonds, and high-yielding currencies.

REUTERS/Brendan McDermid

REUTERS/Brendan McDermid

When investors invariably lost interest in an asset class where valuations could no longer be denied, they flocked to another – witness $150-a-barrel oil, $1,000 gold prices, and crazy gyrations in wheat and soybeans, of all things.

Then the hangover came. Major stock indexes were cut in half. Oil went to $30 a barrel, and investors fled for cover in the dollar and the safety of Treasury bonds.

With U.S. Federal Reserve and other central banks cutting rates to nothing, money worked its way back into the markets, though.

And how: Bespoke Investment Group notes that the S&P’s charge has lifted it to its highest level above its 200-day moving average since 1983, just six months after it hit its lowest point below that average since 1932 – something that’s only happened three times. The Australian dollar is up 23 percent against the dollar this year.

Want more? China’s SSE Composite has gained nearly 70% since hitting a low late last year. Options action has been massive in recent days as investors concentrate bets on momentum-oriented names. The party line on Wall Street is that markets are reconsidering their view of risk, but recent reports noting investment bankers’ newfound interest in securitization of life insurance settlements (surely nothing can go wrong there).

The fear, of course, is this: that the eventual unwind of government stimulus, low interest rates, and protective efforts for large financial companies will reveal a shell, one where economic activity and market gains prove to be a mirage. With some investors still cautious – U.S. money market fund assets, while lower, are still high – it doesn’t take much imagination to see that a few extra nips could bring on another nasty hangover. Until then, party on?

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