What or Who is Driving up Prices?

, On Friday March 19, 2010, 3:15 pm EDT

Investing is about putting the odds in your favor. There are no absolute certainties, but there are high probabilities.

Recently, the probabilities have been skewed by extremes that haven't been seen in years, even decades.

Up until today for example, the S&P 500 (NYSEArca: SPY - News) hasn't had a correction of more than 0.25% for 17 consecutive days. Last Friday, the Nasdaq closed up for the 13th straight session, something that hasn't happened in nearly 20 years.

In January, the percentage of bearish investors had reached a record-low level not seen in nearly two decades.  This extreme investor optimism caused the ETF Profit Strategy Newsletter to state the following on January 16:

'Bullish sentiment has reached a level where it is suffocating nearly all bearish currents and undertones. The natural reaction would be to conform to the trend and turn bullish. We believe that every day that brings higher prices presents a better opportunity for the bears.'

This opportunity came in just a few days when the major indexes a la Dow Jones (DJI: ^DJI), S&P 500 (SNP: ^GSPC) and Nasdaq (Nasdaq: ^IXIC) started to decline about 8%.

The winning streak, as of recent, however, has pushed the major indexes to new recovery highs. Those recovery highs coincide with a number of oddities that are hard to explain, even concerning. What are they?

Lack of conviction

Many have proclaimed the beginning of a new bull market, especially with the break through the S&P 1,150 resistance. Shouldn't such a milestone push happen on high volume?

Average volume for the month of March has been 1.02 billion shares. The average volume from March 1 to March 18 over the preceding five years has been 1.76 billion shares. Not a single March 1 - 18 average has been below 1.7 billion shares.

Investor sentiment discrepancies

As mentioned earlier, investor sentiment reached bullish extremes in January 2009. Even though prices are higher today than at the January 19 highs, investor bullishness has cooled off significantly. In fact, the percentage of bullish retail investors dropped 9.9% last week despite steadily rising prices.

The Volatility Index (Chicago Options: ^VIX), a measure of fear and complacency (low readings generally foreshadow market declines), has fallen from the January 2010 low, to the lowest level since May 15, 2008. This is precisely when the post-2007 market meltdown started.

From May to November 2008, even the best and biggest blue chips stock ETFs such as the Vanguard Large Cap ETF (NYSEArca: VV - News) and iShares S&P 100 Index (NYSEArca: OEF - News) lost 40%.

Mid cap stocks (NYSEArca: MDY - News), small cap stocks (NYSEArca: IYR - News), individual sectors such as financials (NYSEArca: XLF - News), consumer discretionary (NYSEArca: XLY - News), and materials (NYSEArca: XLB - News) fared much worse.

This time around, however, the sentiment extremes and VIX resulted in a minor market top that didn't even last two months. What is different?

A different kind of bailout

The chart below illustrates the government's bailout track record; clearly not impressive. It seems like Washington D.C. has found a different kind of bailout. Ronald Reagan established the platform for this different bailout in 1988.

On March 18, 1988, Ronald Reagan signed Executive Order 12631. Below is an excerpt from Executive Order 12631 - Working Group on Financial Markets - Mar. 19, 1988; 53 FR 9421, 3 CFR, 1988 Comp., p. 559:

'By virtue of the authority vested in me as President by the Constitution and laws of the United States of America, and in order to establish a Working Group on Financial Markets, it is hereby ordered as follows:

Section 1. Establishment. (a) There is hereby established a Working Group on Financial Markets (Working Group). The Working Group shall be composed of:

1) the Secretary of the Treasury, or his designee;

2) the Chairman of the Board of Governors of the Federal Reserve System, or his designee;

3) the Chairman of the Securities and Exchange Commission, or his designee; and

4) the Chairman of the Commodity Futures Trading Commission, or her designee.

Section 2. Purposes and Functions. (a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence.

This quartet has become known as the Plunge Protection Team (PPT).

What's the PPT's job?

The Plunge Protection Team's job description is to prevent another 1987-like 'Black Monday' from occurring (the Dow fell 22.61% on 10-19-1987). How can that be done?

According to John Crudele of the New York Post, Robert Heller, a former member of the Federal Reserve Board, described the modus operandi of the PPT as 'buying market averages in the futures market, thus stabilizing the market as a whole.'

The existence of the PPT was verified by former-Clinton advisor George Stephanopoulos via an appearance on Good Morning America on September 17, 2000. At the time of Mr. Stephanopoulos' appearance, the Nasdaq (Nasdaq: QQQQ - News) was caught up in the dot.com bubble bust and had fallen 25% in less than six months, as did the Technology Select Sector SPDRs (NYSEArca: XLK - News).

What caused the 70% rally

TrimTabs founder and CEO Charles Biderman, added further evidence to suspicions many have had for a while. TrimTabs is a research firm that tracks money flows into the market.

Here's what Mr. Biderman had to say: 'We cannot identify the source of the money that pushed stock prices up so far so fast.' More specifically, the source of about $600 billion net new cash necessary to lift the market's overall capitalization by $6 trillion last year could not be identified.'

Biderman continues, 'We know that the U.S. government has spent hundreds of billions of dollars to support the auto industry, the housing market and the banks and brokers. Why not support the stock market as well? The money did not come from traditional players.

One way to manipulate the stock market would be for the Fed or the Treasury to buy a nominal $60 to $70 billion of S&P 500 stock futures each month for as long as necessary. Depending on margin levels, as little as $5 billion to $15 billion per month was all that was necessary to lift the S&P 500 by 67% (statement was made on January 6, 2010).'

Obviously the Plunge Protection Team was the culprit behind this entire rally. The ETF Profit Strategy Newsletter predicted the onset of this rally previously on March 2nd based on a composite of common sense indicators.

How long can the market exhale without inhaling?

It is, however, possible that this rally lasted beyond its normal expiration date with some friendly help from Washington. What's next?

Nobody knows for sure. But when the present throws you a curve ball, it is often helpful to look at the past for guidance.

The April issue of the ETF Profit Strategy Newsletter compares the current constellation (which could well be a double top) with the double tops of 2000 and 2007. It also takes a look at Japan and many parallels between the Nikkei's 80% meltdown and the U.S. market's performance. The conclusions are enlightening and might protect investors from yet another historic streak - a losing streak.

The Plunge Protection Team wasn't able to prevent the 2000 and 2008 meltdown, how long will it be able to keep this market afloat?