U.S. stocks rallied hard for the second day — recovering from a nasty intraday dip that almost sent the major indices into the red. Investors were encouraged by a similar looking bounce in Chinese stocks overnight heading into the closing bell, with the Shanghai Composite rising 5.3% to snap a five-day losing streak that saw shares drop 23%.
It’s been all about government intervention. Bloomberg reported that Beijing wants stocks to stabilize before the Sept. 3 military parade celebrating the 70th anniversary of the victory over Japan in World War II. And investors continue to feel warm and fuzzy from yesterday’s comments from New York Fed President William Dudley that the case for a September rate hike was suddenly “less compelling” due to market turmoil.
In the end, the Dow Jones Industrial Average gained 2.3%, the S&P 500 gained 2.4%, the Nasdaq Composite gained 2.5%, and the Russell 2000 gained 1.9%.
Energy stocks led the way with a 4.9% gain thanks to a whopping 10.6% rise in crude oil to $42.70 for the best gain since the bull market started in March 2009. The move was spurred by reports Venezuela is requesting an emergency OPEC meeting and is looking to possibly coordinate with Russia to address declining energy prices.
Copper rallied the most since May 2013. Freeport-McMoRan Inc (NYSEARCA:FCX) gained 28.7% after it announced further spending and production cuts in response to lower metal prices and said it would reduce copper output by about 150 million pounds per year in 2016 and 2017. Shares jumped another 19% in after-hours trading after activist investor Carl Icahn disclosed an 8.5% stake in the company and said he may seek board representation.
Still, the late-session slump rattled many nerves and seems to support the case that instead of a V-shaped sustainable rebound, we’re in the midst of a typical “dead cat” bounce. Remember that big upswings of the type we’ve seen over the last 48 hours almost always come within the context of larger downtrends and are driven by short-covering buying.
The selloff was spurred by a widely circulated research note from JPMorgan’s derivative team that technical investors such as Commodity Trading Advisors and Risk Parity funds, which do not rely on fundamentals and are price-insensitive, have been the big drivers of the recent selloff and spike in volatility.
They added that they expect these players to continue selling over the coming weeks for a combined total of upwards of $300 billion. In the current environment of low liquidity, they warn that we could see another crash of the type seen on Monday morning when the Dow dropped more than 1,000 points at the open.
On the economic front, second quarter GDP growth was revised upward to a 3.7% seasonally adjusted annual growth rate, up from 2.3% prior and the best result since the third quarter of 2014 thanks to consumer spending and housing. This, along with the rebound in commodity prices if sustained, could further complicate the Fed’s September rate hike decision.
And Treasury bonds are under pressure on reports Chinese authorities are selling to raise dollars needed to stabilize their currency, the yuan, in the foreign exchange market. As a result, long-term yields have been on the rise this week despite the turbulence in the stock market; a reversal of the usual relationship.
There are a number of reasons to be cautious as well.
For one, the S&P 500 is on the verge of its first “Death Cross” — a move by the 50-day moving average below the 200-day moving average — since 2011. This is a sign of a clear deterioration in the market’s medium-term trend strength. The Dow Jones Industrial Average suffered a Death Cross earlier this month.
Volatility expectations, as measured by the CBOE Volatility Index (VIX), also suggests the selloff isn’t over yet as the “fear gauge” remains elevated. As I write this in late trading on Thursday, the iPath S&P 500 VIX Short-Term ETN (NYSEARCA:VXX) has surged back into positive territory. A leveraged play on volatility, the VelocityShares 2x VIX (NASDAQ:TVIX), was traded for a monthly gain of 144% by Edge subscribers this month amid the rise in fear.
Societe Generale’s Albert Edwards also notes that there is a high probability this is all happening in the context of a new bear market based on the findings of a model that looks at periods when stock price momentum and quality become highly correlated. Then that happens — when investors are aggressively bidding up a narrowing list of good stocks (based on balance sheet measures) while ignoring the rest — it typical marks periods of broad market underperformance.
And finally, market history suggests caution as well. Jason Goepfert at SentimenTrader notes that when the S&P 500 posts a reversal like we’ve just seen, defined as the best one-day gain in more than three years shortly after the worst one-day loss in three years, returns tended to be underwhelming in the weeks that followed.
On average, stocks were down nearly 6% one month later. The last occurrence was in September 2008, on the eve of the financial crisis, in which the index lost 25% in the month that followed.
While the last two days have been nice, some context is needed: The Dow Jones is down 5.9% for the month-to-date and down 6.6% for the year so far.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. Free two- and four-week trial offers have been extended to InvestorPlace readers.
