Tuesday’s mega-rally will have many investors itching to get back into the stock market. But Eric Roseman says chasing a short-term bounce could be a big mistake. Similar up-crashes during the Great Depression were followed by prolonged downturns. But Eric says this could be a good time to “nibble” at some quality blue chips or non-Treasury bonds.

This from the Sovereign Society:

Yesterday’s [Tuesday] spectacular 889 point rally for the Dow ranked as the sixth largest daily percentage gain in history for the world’s most widely followed benchmark. The Dow surged 10.9% on Tuesday and other international markets also followed suit with huge double-digit gains.

But again, don’t get too cocky thinking we’re at the cusp of a new bull market. It won’t happen. The economic backdrop does not portend profit recovery any time soon. Domestic consumption is still declining in the United States as Americans start saving again. A higher savings rate is bearish for earnings.

A big stock market recovery like Tuesday’s probably has many investors itching to get back into the market to recover losses – but that’s a major mistake if you’re unhedged.

Joining Ranks with the Great Depression

Yesterday’s price action joins the dubious list of other extraordinary Dow rallies in history. According to The Wall Street Journal, the Dow’s 889 point rise on Tuesday and its 936 point gain on October 13 are dwarfed by Great Depression rallies of similar magnitude.

Of the top 10 stock market rallies in history, seven occurred during the 1930s, one in October 1987 and two this month. Unfortunately for investors, Tuesday’s 889 point rally was preceded by a 15.3% gain in March 1933, a 14.9% surge in October 1931 and a 12.3% gain in October 1929. That’s not exactly in good company when it comes to impressive rallies.

Global stock markets; however, remain oversold and are likely to extend their first bear market rally since the Fed’s bailout of Bear Stearns in mid-March. All sentiment indicators I follow are extremely bearish, suggesting we’re going to see more gains, however short-lived. The VIX Index – which plunged 16% on Tuesday – is still heavily elevated at 67.

Don’t Jump the Gun

In my view there’s no point chasing this short-term bounce.

The Presidential elections next Tuesday might also provide a jolt to stocks as renewed investor confidence is celebrated once McCain is sent packing his bags. Yet any celebration is unlikely to last beyond several weeks because corporate earnings are still rapidly deteriorating and consensus estimates are too optimistic, meaning more downgrades are coming.

There’s also the big risk surrounding unsettled CDO and credit swaps. There’s about US$60 trillion worth of these things floating around the world. And you can bet that most counter-parties probably can’t honor more defaults should they occur. Credit derivatives need a clearing house and hopefully, they’ll get just that in 2009.

Meanwhile, the credit markets are slowly improving. LIBOR rates are coming off their highs and commercial paper is flowing again, courtesy of the Fed.

I think it’s a good time to nibble – not bite – at your favorite blue-chip stocks and non-Treasury bonds, including investment-grade corporate bonds, intermediate tax-free municipals and TIPs, or Treasury Inflation Protected Securities.

I’d also bet against Treasury’s because long-term yields look awfully low this morning at 4.2% compared to the monster level of Treasury issuance coming our way over the next 12-18 months.

Source: October 28 Up-Crash Joins 1930s Bear Market Action in the Record Books