Can I start by suggesting that we start calling this something besides a bailout plan? This is not a handout to Wall Street, it is an investment by the government. The term bailout has rightfully earned a negative connotation over the past year. The purpose of this article isn’t to argue the semantics of “the plan”, but rather to look beyond any plan and what impact it will have on the market and the economy.

This past week I had a radio interview where I was asked to share my thoughts on “the plan”. I compared it to the knee surgery I had back in February.

Did I want to have surgery on my knee? No, I did not. Was the surgery necessary? If I wanted my knee to work like it used to, then yes. Did I hop up off the operating table and run out of the hospital when it was over? No, it took several months of rehab before it was healthy again.

Let’s equate this to “the plan” now. Does anyone really want to invest $700 billion in bad assets? Of course not. Is it necessary for the health of the economy and the health of the credit markets? Yes it is. Will the economy jump up and run as soon as a plan is passed? Absolutely not. The economy will have to go through a rehab period just like I did with my knee. We can only hope “the plan” works as well as the skillful surgeon that worked on my knee.

Regardless of what happens with “the plan”, the economy is going to continue to struggle for the immediate future. Earnings season starts this week and I expect third quarter earnings results to be down from the second quarter. I don’t think they will be horrendous, but they certainly won’t be anything close to what we saw one year ago.

I am most worried about the fourth quarter results. If the credit market continues to tighten, the economy is going to come to a screeching halt in the coming weeks and months. As bad has it has been, believe it or not it will get worse.

Consumers don’t have anything to spend because of the credit crunch. Businesses can’t spend or access credit because of the credit crunch. How can earnings possibly grow when both individuals and businesses alike are having to cut back on spending?

That is a rhetorical question, because we all know that corporations can’t possibly grow when there is no spending. The third quarter just ended this past week and the credit lock-up didn’t hit full speed until half way through the quarter. This is why I think earnings will only be bad and not terrible.

Obviously, earnings will vary greatly on a case-by-case basis, so when I say they will be a little bit bad, I am talking about overall results.

Looking ahead to the fourth quarter, even with a bailout plan in place, it is going to take at least a month or two for the credit markets to fully free up. This will put us into mid-November at least (half way through the fourth quarter). Investor expectations will certainly play a major role in how the market reacts to the earnings, as they always do.

Part of my concern about the earnings is that now that “the plan” is in place, investors might expect fourth quarter earnings to show vast improvement over the last three quarters and I just don’t think that will happen.

I have presented the chart below many times in the past. The S&P is in a trend channel and is at the bottom rail and we are oversold right now. I would not be surprised to see the index rally up toward that upper rail over the next month or so and then get taking back down toward the end of the year.

The giddiness of having a rescue plan in place may last for a while, but as we all know, investors can be a fickle bunch.

Good luck and good trading,

Rick

Source: Looking Beyond A Bailout: What My Knee Surgery And “The Plan” Have In Common