Temporary stock market bounce or sustainable rally?

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Sarah Connor’s lyrics “Get up and move, Don’t make me act a fool, Just bounce” come to mind when reviewing the performance of financial markets since the Fed’s emergency discount rate cut on August 17.

The invariable question is to what extent the actions of the Fed and other central banks have calmed jittery financial markets. A review of the performance of equities, fixed-interest instruments, currencies and commodities over the past six trading days makes for interesting reading.

The chart below tells the story of the rallies that have characterized stock markets since August 17. Global equities in general appreciated by a handsome 4.1%, with emerging markets being the belle of the ball with a rise of 8.2%.

GLOBAL STOCK MARKETS

mrkts-1.jpg

Source: StockCharts.com


Among fixed-interest instruments the US 3-month T-Bill rate jumped to 4.1%, and bonds were mixed. On the currency front the yen reversed sharply on Thursday and Friday last week, whereas the US dollar resumed its downtrend and the euro its uptrend.

FIXED-INTEREST AND CURRENCY MARKETS

mrkts-2.jpg
Source: StockCharts.com


Commodities gained across the board, with the single exception of energy. The star performer was the agricultural complex (mainly grain and soybeans).

COMMODITIES

mrkts-3.jpg
Source: StockCharts.com


In evaluating whether one is dealing with a mere stock market bounce or with something of more sustainable proportions, it is important to consider the dramatic reversals of four variables – US T-bill rates, the US Volatility Index (VIX), the US Bullish Percent Index and the yen – over the past few days. Let’s consider each of these in turn.

US T-bill rates
The 3-month T-bill rate jumped back to more than 4% on Friday, indicating that some of the panic buying of T-Bills has eased.

mrkts-4.jpg
Source: StockCharts.com


US Volatility Index (VIX)

The easing of the credit crisis tensions saw a sharp reversal of almost 50% in the VIX which should allow stock markets to be less erratic. It was clearly positive for equities as a result of the almost mirror-image relationship between the VIX and the Dow Jones Industrial Index shown in the following chart:

mrkts-5.jpg
Source: StockCharts.com


NYSE Bullish Percent Index

The NYSE Bullish Percent Index, indicating the percentage of stocks in uptrends, reversed sharply from a recent low of 31 to Friday’s close of 44. However, in order for the rally to be sustainable the Index will have to breach the 50% mark, at which level half the stocks will be in uptrends.

mrkts-6.jpg
Source: StockCharts.com


Yen

The graph below depicts the strong inverse relationship between the yen index (blue line) and the Dow Jones World Stock Index (as a proxy for global equities) (black/red line). The sharp decline of the yen over the past few days clearly spurred global stock markets on, allowing the carry trade to live another day.

mrkts-7.jpg
Source: StockCharts.com


There is no denying that the above factors all add to the positive side of global stock markets’ scoreboards. Furthermore, most equity indices are again above their 200-day moving averages, having come off very oversold levels as illustrated by the chart of the S&P 500 Spyders below.

mrkts-8.jpg
Source: StockCharts.com


But, and herein lies the big catch, the rise in prices over the past week happened on very light trading volume. In the absence of stronger volume (i.e. broader participation) I will for the moment reserve judgement on whether we are in fact dealing with anything more than an oversold bounce. I will also be watching my monthly charts very carefully by the end of trading on August 31 to ascertain to what extent stock markets’ primary trends are still intact.

OverSeas Radio Network

4 comments to Temporary stock market bounce or sustainable rally?

  • stevo

    Short term, I believe that we are soon to test the recent, climactic low on the SPX at 1370. I do not believe that this test will see a violation of that support level. Much of the prevailing negativity in sentiment is likely to be wrung out of the markets this week.

    Further, I believe that the broader market is on the verge of making imminent new highs. This projected upleg could present as large as a 13% gain from present levels. Upside target projection from a 2-box, 1% P&F chart is 1667. A rough Fibonacci expansion based upon the recent high to low count is 1677 (1560-1370=190×1.618+1370=1677.) And a Gann circle chart projection at 360d gives an upside price target of 1682. Average upside target = 1675.

    Also, since the latest yield curve is positively sloped, we would probably do well in allocating our resources to inelastic firms with high betas.

    MARKET SERENITY
    by C. Placid Waters

    When the markets are
    Screamingly volatile,
    And your last trade seems
    More enemy than friend,
    A feeling of peace
    Comes when you reconcile
    Your position to
    The underlying trend!

  • Tom Finch

    I enjoy your postings keep up the good work.
    The market (S&P 500) is still in a long term up
    trend but in an intermediate downtrend. We’ve gone from a very over sold to a over bought
    market. Which will prevail? My guess, based on the economic outlook and lowered earnings
    expectations the intermediate downtrend will
    continue.
    Best regards, and thanks for your postings

  • “Expect this Bear Market Rally to culminate in a Spike…. followed by an Avalanche the very next day”.

    We could be peaking next week, the pattern in all stock indices signal a dramatic reversal ahead, but first we need a final Blow-out phase ending in a Spike. This is no more than a sucker’s rally meant to lure in, every last fool who’s afraid of missing the next Bull Market, right at the top This includes your highly respected money manager, the one who markets his impressive track record “in good times and bad”, referring to the brief interlude period between 2000 and 2003, when in fact he’s never experienced anything resembling a Bear Market. It’s precisely those Bull market habits of success, augmented by arrogance, which will lead to his downfall – and yours. He can’t resist getting fully invested with your money, just before we collapse. When there are no more buyers left, the same herding instinct that caused the Spike, will reverse as abruptly as a herd of stampeding elephants, only by then it’ll be too late…. liquidity will have completely dried up. With no buyers left, the Market can only Crash.

    But I’m getting ahead of myself; in the meantime, we are building a base from which to launch the final Spike. This base building phase is analogous to winding a spring tightly, so that when released, it thrusts the object into the air with great speed. As part of this spring compression, on Tuesday, the broad indices will all be down, perhaps significantly. Having read this, you will know that I don’t have a crystal ball; this scenario is typical of bursting bubbles. Each time it plays out the same, but only after all the participants of the previous crash have long passed away. The similarity is contingent upon human psychology, which has not changed since the dawn of man.

    The minimum drop for the Dow next week is 13,150, down from Friday’s close of 13,378, and could be substantially deeper. The comparable minimum plunge for the S&P 500 is 1450, down from Friday’s close of 1479’s. It won’t take much to spook the Market at this stage of the game. Intuitively we sense the danger, but we allow our intellect to block out the warning. Oddly enough, the Financial and Real Estate stocks should rally for a couple more days, only to get knocked down sequentially in similar fashion.

    Cataclysmic events usually coincide with eclipses. A lunar eclipses converging on the cycle turn dates of August 28th and 31st will likely mark this climax. One possibility is that we Spike on the 28th and bottom temporarily on the 31st. Another is that we peak twice, first on the 28th, come down hard, then bounce back up into the 31st. The former possibility would appear more plausible, although the second scenario is too risky to ignore for those going short, since a margin call could potentially wipe out your entire position, before the Crash even gets under way. At times these cycle turn dates can occur with pinpoint accuracy, while at others, they totally off the mark.

    Neither the Fed nor anyone else can turn around pessimism; it has already crept into the collective consciousness and is rapidly gaining critical mass. A slew of 90% down days last month and this month, meaning 90% of the up plus down volume and 90% gainers plus losers earlier this month and last month attest to the level of pessimism, characteristic of major Bear Markets. This final rally is based upon fantasy and hope, rather than fundamentals. Keeping our fingers crossed that someone will rescue our homes, our savings, our retirement funds, and our standards of living. At some point, and likely next week, reality will set in. As sellers far exceed buyers, causing prices to plummet. In the 1987 Crash the Fed stepped in to buy futures, just as the crash had run its course. It’s likely they feel confident of having an ace in hole capable of turning the market around. However, this time when they attempt it again, they could bankrupt the Federal Government. We’re pretending that we have Goldilocks economy for just a little while longer, but once the market collapses, reality sets in − the reality of economic and psychological depression − for many, a living hell. Although shorts could lose another 15-20% in this rally, longs are playing a far more dangerous game by waiting to get out. Just as liquidity dried up in the Real Estate and Financial Markets, it will surely run dry in the stock market.

    Eduardo Mirahyes
    Exceptional Bear

    http://www.exceptional-bear-market-letter.com/index.html

  • I posted on my Saturday post an indicator that is virtually 100% sensitive to short term market tops. This indicator was pointing to a ST-top. Pessimism is now prevalent, so I expect a limited drop for the S&P.

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