The govt has already given the bad banks a wink and nod to manufacture earnings over the next two quarters so as to not have to raise as much capital as the govt is requiring banks do based on the stress test results. They are giving bad banks a way to “earn” their way out of meeting the capital requirements of roughly $70 billion. In fact, today’s most intriguingly headline from Bloomberg today was JPMorgan $29 Billion WaMu Windfall Turned Bad Loans Into Income:

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce. “The banks will wring revenue from the wreckage,” said former Lehman exec Robert Willens.

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine. “One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said.

Daily E-mini SP500 “Consumer Confidence" Chart

In short, market participants are being coaxed back into the stock market through self-reinforcing Michigan sentiment and consumer confidence reports, manipulated earnings reports from the financials, upwardly biased jobs reports from the BLS, not to mention the bank stress-test results and TARP buyback applications. All of these inputs can push the stock market considerably higher going into the peak financial earnings season in mid-July with all trade above today’s low at 877 and trump much of the bearish momentum from 2008-09.

The stock market climbed the wall of worry surrounding the bank stress-tests and set a short term high on May 7. The pullback off the May 7 high ended with the announced TARP buyback applications on May 18. The TARP buyback rally ended on May 20 and sold off into Consumer Confidence Tuesday, May 26.  The stock market, we have repeatedly noted, tends to set short term lows on Consumer Confidence Tuesdays. Bullish responses from investors to a consumer confidence report are a short term bullish indicator.

The consumer confidence rally this week may mimic the TARP buyback rally last week. If that is the case, the short term price targets are 914-917 and 925. Support above the CC Tuesday low should be 894-898. The week and month will taper to a close with a bullish input from the Michigan Consumer Sentiment. The month will end contra-seasonally on a high note. After yet another bullish input from the ISM index on Monday June 1st, the first week of June could be sideways to lower ahead of the bearish June NFP report.

Since the March 2000 high to the May 2009 high, the price action of the SP500 has been fairly well defined by the nine month 39 and 78 week moving averages. These are nine and eighteen month moving averages. The price action is negative when these averages are bearishly sloped and positive when bullishly sloped. As of May 2009, the stock market is now facing its second challenge of the shorter term 9 month moving average. Not surprisingly, the stock market has hesitated to breach this moving average. If it is breached, confidence can be said to be trumping this bearish moving average, and over time, we would expect the SP500 to be able to challenge the more formidable eighteen month bearishly sloped moving average.

If the “green shooters” are the squeaky wheel that gets the grease, the SP500 should rebound by mid to late June as marginal buyers are encouraged back into the market. If the May 26 consumer confidence low at 877 fails, this more bullish scenario is temporarily on hold.